Greece faces bumpy road to recovery, say JPMAM’s Toschi and Elliott

Maria Toschi and Tom Elliott, global strategists at JP Morgan Asset Management, see recovery in Greece – but it will be a bumpy ride.

Although it has been little reported outside of Greece, there is a growing optimism in the country that the worst of the crisis may be passing. This is important for the global re-risking investment theme: if Greece can present itself as a recovering economy, having taken the Troika’s medicine of fiscal austerity and supply-side reform, the reform agenda of the European Central Bank (ECB) and International Monetary Fund (IMF) will be given a further boost. If Greece stumbles, the vested interests in other peripheral eurozone nations will be encouraged to delay supply-side changes and with it growth and debt sustainability.

Re-risking signals are coming from Greece

So what are the grounds for optimism? In January, the Greek government won a long and highly symbolic battle against Athens metro workers over pay scales. Disruptions and strikes persist, but the government has an important victory under its belt.

Despite the economy entering its sixth year of recession, the IOBE consumer confidence index is near a two-year high. Three Greek companies, OTE, Fage and Titan, have been able to issue debt on capital markets in recent months. Meanwhile, the government is forecast to run a primary budget surplus this year and a return to GDP growth is expected in 2014.

This has allowed Greece to join in the ‘risk-on’ rally of recent months. Greek ten-year government bond yields have dropped below 10%, while the Athens Stock Exchange (ASE) main index has rebounded by roughly 10% year to date, and more than 100% since June 2012. Standard and Poor’s has upgraded Greece’s credit rating to B-minus, with a stable outlook. Commentators are no longer predicting Greece’s imminent exit from the euro. (IOBE is the Foundation for Economic and Industrial Research).

True, the labour market remains weak. At the end of 2012 the unemployment rate climbed to 24%, which clearly hinders the restoration of domestic demand.

However, average unit labour costs have declined 14% since the 2009 peak. The effect of this, together with weak domestic demand, has been a steady improvement in the current account deficit, which fell to 5% in September 2012, from 16% in 2009.

Tackling the persistent current account deficit is key to long-term growth, and to debt sustainability, so this is welcome news.

Supply-side reform

It is not only the Athens metro workers who are being asked to reform. The Troika has made quite granular recommendations, which include specific headcount reductions in the civil service, and improving the efficiency of court proceedings.

Supply-side reforms also include the liberalisation of regulated professions, much of the retail sector and of tourism. Steps have been made to assess tax evasion, and clarify land ownership. The potential revenue to be gained is substantial: estimates suggest current annual tax revenue losses are in the region of €30bn.

Privatisations have not yet been started. However, the government recently presented a list of state-owned companies, golden shares (mainly in utilities) and properties to sell. On the downside, proceeds from these privatisation initiatives may only amount to €23.5bn through 2020, half of what was initially projected.

Bank recapitalisations should be finalised by the end of April 2013. Total capital needs are estimated at €40.5bn, of which €27.5bn corresponds to the four biggest domestic lenders. Private shareholders should cover at least 10% of new common equity capital to ensure the credit institutions are privately run.

After a long period of a decline in banking deposits, deposits started to recover in the second half of 2012 and inflows also came from abroad. The successful conclusion of the government bond buyback programme, at the end of 2012, has helped to make debt-to-GDP targets, set by the Troika, achievable goals. To date, 80 measures of spending cuts have been identified, with the majority of savings coming from public wages and social spending. The 2010 pension reform should reduce public pension spending as a percentage of GDP from 17% to 14% in 2013. (Sources: ECB Monthly Bulletin, January 2013, and IMF Country Report, January 2013.)

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