European choice: Greek bailout Mark II – it’s a default !

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WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

The European debt crisis has evolved rather quickly since my last column, “Greece is Bankrupt” (July 2). The European leadership was clearly in denial. The crisis has lurched from one “scare” to another. First, it was Greece, then Ireland, then Portugal; and then back to Greece. On each occasion, European politicians muddled through, dithering to buy time with half-baked solutions: more “kicking the can down the road.” By last week, predictably, the crisis came home to roost. Financial markets in desperation turned on Italy, the euro-zone's third largest economy, with the biggest sovereign debt market in Europe. It has 1.9 trillion euros of sovereign debt outstanding (120% of its GDP), three times as much as Greece, Ireland and Portugal combined.

Over the next two weeks the EU must come up with a second Greek bailout which could be as high as £107billion on top of the £98billion in rescue loans agreed for Greece in May 

The situation has become just too serious, if contagion was allowed to fully play out. It was a reality check; a time to act as it threatened both European integration and the global recovery. So, on July 21, an emergency summit of European leaders of the 17-nation euro-currency area agreed to a second Greek bailout (Mark II), comprising two key elements: (i) the debt exchange (holders of 135 billion euros in Greek debt maturing up to 2020 will voluntarily accept new bonds of up to 15 to 30 years); and (ii) new loans of 109 billion euros (through its bailout fund and the IMF). Overall, Greek debt would fall by 26 billion euros from its total outstanding of 350 billion euros. No big deal really.

Contagion: Italy and Spain

By mid-July, the Greek debt drama had become a full-blown euro-zone crisis. Policy makers' efforts to insulate other countries from a Greek default, notably Italy and Spain, have failed. Markets panicked because of disenchantment over sloppy European policy making. For the first time, I think, investors became aware of the chains of contagion and are only now beginning to really think about them.

The situation in Italy is serious. At US$262bil, total sovereign claims by international banks on Italy exceeded their combined sovereign exposures to Greece, Ireland, Portugal and Spain, which totalled US$226bil. European banks account for 90% of international banks' exposure to Italy and 84% of sovereign exposure, with French & German banks being the most exposed. Italy & Spain have together 6.3 trillion euros of public and private debt between them. Reflecting growing market unease, the yield on Italy's 10-year government bonds had risen to 5.6% on July 20, and Spain's, to 6%, against 2.76% on German comparable bunds, the widest spread ever in the euro era.

Italy and Spain face different challenges. Spain has a high budget deficit (9.2% of GDP in 2010, down from 11.1% in 2009) the target being to take it down to 6% in 2011 which assumes high implementation risks. Its debt to GDP ratio (at 64% in 2011) is lower than the average for the eurozone. The economy is only gradually recovering, led by exports. But Spain suffers from chronic unemployment (21%, with youth unemployment at 45%), weak productivity growth and a dysfunctional labour market.



It must also restructure its savings banks. Spain needs to continue with reforms; efforts to repair its economy are far from complete and risks remain considerable. Italy has a low budget deficit (4.6% of GDP) and hasn't had to prop-up its banks. But its economy has barely expanded in a decade, and its debt to GDP ratio of 119% in 2010 was second only to Greece. Italy suffers from sluggish growth, weak productivity and falling competitiveness. Its weaknesses reflect labour market rigidities and low efficiency. The main downside risk comes from turmoil in the eurozone periphery.

Another decade of stagnation also poses a major risk. But both Spain and Italy are not insolvent unlike Greece. The economies are not growing and need to be more competitive. The average maturity of their debt is a reasonable six to seven years. But the psychological damage already done to Europe's bond market cannot be readily undone.

The deal: Europeanisation of Greek debt 

The new bailout deal soughts to ring-fence Greece by declaring “Greece is in a uniquely grave situation in the eurozone. This is the reason why it requires an exceptional solution,” implying it's not to be repeated. Most don't believe it. But to its credit, the new deal cuts new ground in addition to bringing-in much needed extra cash - 109 billion euros, plus a contribution by private bondholders of up to 50 billion euros by mid-2014. For the first time, the new framework included solvent counterparties and adequate collateral. For investors, there is nothing like having Europe as the new counterparty instead of Greece. This europeanisation of the Greek debt lends some credibility to the programme. Other new features include: (i) reduction in interest rates to about 3.5% (4.5% to 5.8% now) and extension of maturities to 15 years (from 7 years), to be also offered to Ireland and Portugal; (ii) the European Financial Stability Facility (EFSF), its rescue vehicle, will be allowed to buy bonds in the secondary market, extend precautionary credit lines before States are shut-out of credit markets, and lend to help recapitalise banks; and (iii) buy collateral for use in the bond exchange, where investors are given four options to accept new bonds carrying differing risk profiles, worth less than their original holdings.

The IIF (Institute of International Finance), the industry trade group that negotiated for the banks, insurance funds and other investors, had estimated that one-half of the 135 billion euros to be exchanged will be for new bonds at 20% discount, giving a savings of 13.5 billion euros off the Greek debt load. Of the 109 billion euros from the new bailout (together with the IMF), 35 billion euros will be used to buy collateral to serve as insurance against the new bonds in exchange, while 20 billion euros will go to buy Greek debt at a discount in the secondary market and then retiring it, giving another savings of 12.6 billion euros on the Greek debt stock.

Impact of default

Once again, the evolving crisis was a step ahead of the politicians. There are fears that Italy and Spain could trip into double-dip recession as global growth falters, threatening the debt dynamics of both countries. This time the IMF weighed in with serious talk of contagion with widespread knock-on effects worldwide. Fear finally struck, forcing Germany and France to act, this time more seriously. The first reaction came from the credit rating agencies. Moody's downgraded Greece's rating three notches deeper into junk territory: to Ca, its second-lowest (from Caa1), short of a straight default. Similarly, Fitch Ratings and Standard & Poor's have cut Greece's rating to CCC.

They have since downgraded it further. They are all expected to state Greece is in default when it begins to exchange its bonds in August for new, long-dated debt (up to 30 years) at a loss to investors (estimated at 21% of their bond holdings). The rating agencies would likely consider this debt exchange a “credit event”, but only for a limited period, I think. Greece's financial outlook thereafter will depend on whether the country would likely recover or default again. History is unkind: sovereigns that default often falters again.

What is also clear now is the new bailout would not do much to reduce Greece's huge stock of sovereign debt. At best, the fall in its debt stock will represent 12% of Greece's GDP. Over the medium term, Greece continues to face solvency challenges. Its stock of debt will still be well in excess of 130% of GDP and will face significant implementation risks to financial and economic reform. No doubt the latest bailout benefitted the entire eurozone by containing near-term contagion risks, which otherwise would engulf Europe. It did manage to provide for the time being, some confidence to investors in Ireland, Portugal, Spain and Italy that it's not going to be a downward spiral. But the latest wave of post-bailout warnings have reignited concerns of contagion risks and revived investor caution.

Still, the bailout doesn't address the very core fiscal problems across the eurozone. This is not a comprehensive solution. It shifted additional risks towards contributing members with stronger finances and their taxpayers as well as private investors, and reduces incentives for governments to keep their fiscal affairs under strict check. This worries the Germans as it weakens the foundation of currency union based on fiscal self-discipline. Moreover, the EFSF now given more authority to intervene pre-emptively before a state gets bankrupt, didn't get more funds.

German backlash appears to be also growing. While the market appears to be moving beyond solvency to looking at potential threat to the eurozone as a whole, the elements needed to fight systemic failure are not present. At best, the deal reflected a courageous effort but fell short of addressing underlying issues, leading to fears that Greece-like crisis situations could still flare-up, spreading this time deep into the eurozone's core.

Growing pains

The excitement of the bailout blanked out an even bigger challenge that could further destabilise the eurozone sluggish growth. The July Markit Purchasing Managers Index came in at 50.8, the lowest since August 2009 and close enough to the 50 mark that divides expansion from contraction. And, way below the consensus forecast. Both manufacturing and services slackened. Germany and France expanded at the slowest pace in two years in the face of a eurozone that's displaying signs it is already contracting. Looking ahead, earlier expectations of a 2H'11 pick-up now remains doubtful.Lower GDP growth will require fiscal stimulus to fix, at a time of growing fiscal consolidation which threatens a downward spiral. At this time, the eurozone needs policies to restart growth, especially around the periphery. Without growth, economic reform and budget restraints only exacerbate political backlash and social tensions. This makes it near impossible to restore debt sustainability. Germany may have to delay its austerity programme without becoming a fiscal drag. This trade-off between growth and austerity is real.

IMF studies show that cutting a country's budget deficit by 3% points of GDP would reduce real output growth by two percentage points and raise the unemployment rate by one percentage point. History suggests growth and austerity just do not mix. In practical terms, it is harder for politicians to stimulate growth than cut debt.

Reform takes time to yield results. And, markets are fickle. In the event the market switches focus from high-debt to low-growth economies, a crisis can easily evolve to enter a new phase one that could help businesses invest and employ rather than a pre-mature swing of the fiscal axe. Timing is critical. It now appears timely for the United States and Europe to shift priorities. They can't just wait forever to rein in their debts. Sure, they need credible plans over the medium term for deficit reduction. More austerity now won't get growth going. The surest way to build confidence is to get recovery onto a sustainable path only growth can do that. Without it, the risk of a double-dip recession increases. Latest warnings from the financial markets in Europe and Wall Street send the same message: get your acts together and grow. This needs statesmanship. The status quo is just not good enough anymore.

Former banker Dr Lin is a Harvard educated economist and a British chartered scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my.

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A new dawn in world economy?

Review by Thomas Lee tomlee48@gmail.com

A new dawn in world economy?
Title: Uprising
Will Emerging Markets Shape or Shake the World Economy?
Author: George Magnus
Publisher: John Wiley & Sons Ltd

At first glance, the title Uprising gives one the impression that the book is concerned about rebellion or revolt, or matters related to violent political conflicts involving armed resistance.

However, after reading its small-print sub-title Will Emerging Markets Shape or Shake the World Economy? and a quick browsing through its content, one realises that the book is actually an in-depth analysis of the contemporary global economy, in particular the influence and impact of the new emerging markets with the focus on the shift of economic power from the West to the Orient, especially China.

Its author George Magnus is a prominent investment banker and global economist, who has been acknowledged as the key analyst who had predicted the recent world financial crisis in early 2007. He is a senior economic adviser at the UBS Investment Bank in London, and had held similar posts at the Union Bank of Switzerland and SG Warnurg.

Magnus is also a popular and respected public commentator on world financial matters, contributing frequently to the Financial Times of London, the BBC, Bloomberg, the CNBC and several other prominent economic, business or financial publications. He is also author of the 2008 definitive international economic analytical book The Age of Aging: How Demographics are Changing the Global Economy and Our World. 

Hence, Uprising is not simply any ordinary run-of-the-mill book, but a major authoritative book which anyone concerned with the contemporary global economy and the direction it is moving should read and reflect deeply on. What Magnus said in his book should not be treated lightly as he is no false prophet when it comes to matters of international economic wheeling and dealing.



Magnus begins his book with an incisive narration and analysis of the world events building up from the first year of the new 21st century to the current global economic scenario. He gives a sharp observation, and penetrating and critical analysis of events in China, including the implications of a world sporting event like the August 2008 China Olympic Games, which took place sandwiched between the May 2008 Great Sichuan Earthquake which claimed nearly 70,000 lives, and the October 2008 world financial earthquake following the collapse of the US investment bank Lehman Brothers, which, as Magnus puts it, “brought the world economy to the brink of an economic Armageddon, unrivalled since the Great Depression of the 1930s”.

In his 358-page book, Magnus sets out to explain the impact and effect that the 2008 financial crisis has on the major emerging markets, and why the rich developed Western nations is going all out to challenge and curb their increasing threats, especially of China and India, in the global economic order.

A major theme of the book as Magnus puts it, is that “the West’s financial crisis sparked a major change in the structure of the world economy, and that China’s capacity to also embark on structural change voluntarily is weak, unless it is specially geared to the long-run interests of the Communist Party’s grip on power”.

This authoritative definitive book examines the two major economic powers and leading emerging markets in Asia – China and India – and several minor but significant markets in Eastern Europe, and also Turkey.
Currently, the emerging markets are headline news. And the question uppermost in the minds of political and business leaders in all these emerging markets of the world is what will happen following the 2008 world financial crisis and what does the future mean and hold for global finance, trade and commerce.

Magnus provides significant suggestions and pragmatic guidelines to resolve this global economic dilemma.

He presents a persuasive and cogent perspective on China and the other emerging markets from a post-financial crisis situation, urging those with economic potency to seriously reconsider their attitude and approach to the emerging new world economic order. A fundamental matter to critically and analytically examine is the question of what economic reforms are needed to meet the new global goals.

Magnus should most be appreciated for offering a convincing critical analysis of what the future global economy may look like – not merely for the emerging markets, but for policy-makers, businesses, financiers, investors, economists, and even ordinary citizens concerned with the economic well-being of their nation and the world.

Magnus deals with matters such as climate change, commodity prices, and world demographic trends, and gives valuable insights into the implications of these issues for the world economy.

One significant question Magnus deals with is whether the 21st century belongs to China. The Communist nation operating on enterprise capitalism for the last 30 years is now all set to regain what Magnus has pointed out in his book as its premier economic power it held from ancient times till the early part of the 19th century.

For all intent and purpose, China is set for an economic renaissance. It will soon regain its ancient mantle as a world economic power it lost when its reticent conservative bureaucracy forced it into international relation isolation while Europe moved economically forward with an industrial revolution in the 19th century.

The Uprising by the plucky economic seer Magnus is certainly essential reading for anyone who wants to understand and care about the future of the global economy.

Understanding the context, content and challenges of the world economic scenario during the first decade of this century is certainly vital for those responsible for making policies, plans and programmes to chart the direction, set the trend, and strive for vigorous economic success in their nations.

Thanks to Magnus, his book has provided the seeds for the planting, growing and harvesting of serious objective thinking, critical pragmatic evaluation, constructive practical ideas, and effective and efficient creative implementation of economic policies, plans and programmes.

Understanding The Rise Of China [VIDEO]

http://www.dump.com/2011/01/25/understanding-the-rise-of-china-video/

IMF - Lagarde’s Challenges

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Raghuram Rajan

CHICAGO – Now that the dust has settled over the selection of the International Monetary Fund’s managing director, the IMF can return to its core business of managing crises. Christine Lagarde, a competent and well-regarded technocrat, will have her hands full with three important challenges.

The first, and probably easiest, challenge is to restore the IMF’s public image. While the criminal case against Dominique Strauss-Kahn on sexual-assault charges now seems highly uncertain, the ensuing press focus on the IMF suggests an uncontrolled international bureaucracy with unlimited expense accounts, dominated by men with little sense of restraint.

Fortunately, the truth is more prosaic. Top IMF staff face strict limits on their allowable business expenses (no $3,000 per night hotel rooms, despite reports in the press), and are generally underpaid relative to private-sector executives with similar skills and experience.

The IMF, like many organizations where workers spend long trips together, has its share of intra-office romances. But the environment is professional, and not hostile to women. A previous incident in which Strauss-Kahn was let off lightly for an improper relationship with a subordinate clearly suggests that the Fund needs brighter lines for acceptable behavior and tougher punishment for transgressions. But other organizations have dealt with similar issues; the IMF needs to make the necessary changes, and, equally important, get the message out that the DSK incident was an aberration, not the tip of the proverbial iceberg.

Mess in Europe

The second, and perhaps most difficult, challenge facing Lagarde, is the mess in Europe, where the IMF has become overly entangled in eurozone politics. Typically, the IMF assesses whether a country, after undertaking reasonable belt-tightening measures, can service its debt – and lends only when it is satisfied that it can. The entire objective of IMF lending is to help finance the country while it makes adjustments and regains access to private borrowing. This also means that a country with too much debt should renegotiate it down before getting help from the IMF, thereby avoiding an unsustainable repayment burden.

Perhaps swayed by promises of eurozone financial support (and Europe’s desire to prevent default-fueled financial contagion from spreading to countries like Spain and possibly Italy), the IMF took a rosier view of debt sustainability in countries like Greece than it has in emerging markets. But this has not “helped” such countries, for the availability of soft credit from the eurozone or the Fund only enables a greater accumulation of debt.



Ultimately, debt can be repaid only if a country produces more than it spends. And the higher the debt, the less likely it is that the country will be able to achieve the mix of belt-tightening and growth that would enable it to generate the necessary surpluses. Delayed restructuring eventually means more painful restructuring – after many years of lost growth.

If troubled eurozone countries, especially Spain, start growing rapidly again, there is still a “muddle-through” outcome that might work. With too-big-to-save countries like Spain in the clear, the debt of highly-indebted peripheral countries like Greece could be written down through interest waivers, maturity extensions, and debt exchanges. The eurozone – and the European Union – could survive its fiscal crisis intact.

Significant haircut

But having failed to insist on an up-front restructuring, the IMF will face problems. With private investors reluctant to lend more or even to roll over existing debt, the bulk of Greek debt at the time of any restructuring (or whatever it is euphemistically called) will be from the official sector. How the resulting losses imposed on debt holders will be divided between the various eurozone institutions and the IMF is anyone’s guess. For the first time in its history, the Fund might have to take a significant “haircut” on its loans, and it will have to prepare its non-European shareholders for it.

 Being independent

A greater dilemma will emerge if the muddle-through strategy does not seem to be working. At some point, the IMF’s strategy, which should be focused on the distressed country’s citizens and its creditors, should depart from that of the eurozone, which is more willing to sacrifice individual countries’ interests for the larger interest of the monetary union. Lagarde’s challenge will be to chart a strategy for the IMF that is independent of the eurozone’s strategy, even though she has been intimately involved in formulating the latter.

The third challenge for Lagarde concerns the circumstances of her election. It is not inconceivable that a number of emerging-market countries will get into trouble in the next few years. Will the Fund require the tough policy changes it has demanded of countries in the past, or will Lagarde’s need to show that she is not biased towards Europe mean that future IMF interventions will become more expansive and less demanding? A kinder, gentler Fund is in no one’s interest, least of all the distressed countries and the world’s taxpayers.

Finally, there is a challenge that seems to be pressing, but is not. In her campaign for the position, Lagarde emphasized the need for diversity among the IMF’s top management. But what is really needed is the selection and promotion of the best people, regardless of national origin, sex, or race.

Clearly, the IMF’s existing culture and history will bias its selection and promotion of staff towards a certain type of person (for example, holders of PhDs from US universities). That commonality in backgrounds among IMF personnel allows the Fund to move fast in country rescues, not wasting time in endless debate. In the long run, more diversity is needed. But if it is attempted too quickly, in order to paper over the fact that a European is in charge once again, the Fund risks jeopardizing its key strength.

The IMF is perhaps the central global multilateral economic institution at a time when such institutions are needed more than ever. Lagarde arrives to lead it at a difficult time. We all have a stake in her success.

Raghuram Rajan, a former IMF chief economist, is a professor at the University of Chicago’s Booth School of Business.

Greece is bankrupt !

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WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

A rose by any other name would smell as sweet. In the case of Greece, default by any other name just stinks! The plain truth: Greece is bankrupt. Greece's sovereign debt crisis deepens daily as the gap in reality widens between politically driven “in denial” views of European Union (EU) leadership and market-place views as reflected in 5-year Greek bonds trading at a yield close to 20%; Standard & Poor cutting Greece's rating to triple-C (the lowest credit rating ever); and highest premiums payable on CDS (credit default swaps, used as insurance to protect investors against defaults) on Greek debt. Probability of default by Greece over the next 5 years has jumped to 86%.

Today, a CDS will cost US$2mil annually to insure US$10mil debt over 5 years. Markets have indicated for some time Greece suffers from a condition of bankruptcy rather than a crisis of liquidity (i.e. cash-short).

This simply means Greece cannot survive without significant debt relief and restructuring, combined with an overhaul of the ways its government collects revenue and expends. In essence, Greece has 2 major problems: it has too much debt and it cannot grow. I am afraid more and more of EU will get contaminated.

Trouble in Greece: A Greek flag at the Akropolis in Athens. Millions of Greeks participated in a strike to oppose new heavy austerity measures. — EPA
 

The Greek illusion

Greece should not have been into the euro in the first place. It failed to join in 1999 because it did not meet fiscal criteria. When it did so in 2001, it was through phony budget numbers. As Twitter R. Cohen wrote: “Europe's bold monetary union required an Athenian imprimatur to be fully European. So everyone turned a blind eye.” But Greece has had an awful history. The 1912-13 war wrested northern Greece from Ottoman control. Then came the massive exchange of 1923 where 400,000 Muslims were forced from Greece to Turkey and 1.2 million Greek Orthodox Christians, from Turkey to Greece.

A military dictatorship followed in the 1930s; brutal German occupation in 1941-44; and a civil war in late 1940s. There was the rightist dictatorship of 1967-74, not to mention the on-going conflict with Turkey over Cyprus. In “Twice a Stranger”, B. Clark wrote of Greece as a society “where blood ties are far more important than loyalty to the state or to business partners.”

It would appear EU membership provided some balm to Greek wounds. It detoxifies history. So Greece took to the EU as a passport to live on the never-never. The bottom line: a monetary union among divergent economies without fiscal or political union support has no convincing historical precedent. For a while, the easy-money, easy-lifestyle allowed everyone to overlook peripheraleconomies like Greece from becoming uncompetitive with the euro (with no drachma to devalue) and not showing any signs of “converging” (closing the gulf between strong and weak nations within EU), but amassing unsustainable deficits and debt. Greece remains a nation suspicious of outsiders and a place where state structures command scant loyalty.

This does not abode well. We now see a Greece resentful of deep spending cuts, and of the sale of state assets meted out by technocrats from outside. They feel the poor and unemployed are paying for the errors of politicians, and a globalised system that punishes those left behind. Strikes and violence are a measure of a EU that now leaves most Greeks unmoved by the achievements of European integration.

Greece is insolvent

It is true a sovereign state, unlike a firm, has the power to tax. In theory, it can tax itself out of trouble. But there is a limit on how far it can tax before it becomes politically and socially unsustainable. Already, Greece has a debt/GDP ratio of 143% in 2010, rising to 150% this year. It is too high to convince creditors to continue lending.

In practice, the market expects Greece to reduce its debt ratio considerably before it can borrow again. This means it has to create a primary budget surplus (revenue less non-interest expenditure) in excess of 8% of GDP to be credit worthy again. Among advanced nations, none (except oil-rich Norway) has managed to attain a durable primary surplus exceeding 6% of GDP. Greece is insolvent.

This is a dire situation. Government bonds serve as a reference asset by setting the “riskless” rate of interest. So any doubts about its value can cause turmoil. Indeed, solvency of the Greek financial system is at risk. So are other European financial institutions. Equally vital is contagion with its sights set firmly on other debt-distressed nations notably Ireland, Portugal, Spain and Italy.

But it doesn't stop there. Top Europeans have warned contagion to EU members could spark off a crisis bigger than the Lehman Brothers collapse in Sept 2008. So, it is not difficult to understand the hard line taken by the European Central Bank (ECB) aimed primarily to protect European banks which need time to strengthen their capital base. For obvious reasons, it has rejected any sort of restructuring of debt raising the spectre of a chain reaction, and threatening to punish any restructuring (re-negotiation of the terms of maturing debt) by cutting banks' access to liquidity.

Moreover, credit rating agencies would deem any such action as a default (i.e. non-payment of due debt). With Greece insolvent, the EU has taken the narrow road of beefing up the financing for Greece (which can't refinance itself in the market), while using moral suasion to persuade private creditors to roll-over their bonds. It is buying breathing space.



More denial doesn't work just prolongs the agony. What's happening to Greece is distressful. Over the past 12 months: the number of unemployed rose by close to 40%; unemployment is above 16% among youths, it's a devastating 42%. IMF estimates showed its GDP contracted by 2% in 2009 and 4.5% in 2010 and will shrink by 3-4% this year.

Despite severe fiscal austerity, its budget deficit will improve only slowly: from -15.4% of GDP in 2009 to -9% in 2010 and -7% this year (and estimated at -6.2% in 2012). That's a long way to surplus! Greece has become so uncompetitive its current balance of payments deficit was -11% of GDP in 2009, -10% in 2010 and optimistically estimated at -8.2% this year (and at -7.2% in 2012). Truly, Greece is in “intensive-care” a solvency crisis, not just caught in a short-term cash crunch (yes, it also does not have cash to meet its next debt payment before July 15).

Even at today's low interest rates, Greece's government interest payments alone amounted to 6.7% of GDP, against 4.8% for Italy and considerably higher than all other major European nations and the United States (2.9%). Even Portugal's ratio is lower at 4.2%.

Political solution: slash and burn won't work

What Greece needs is deep economic reforms or fiscal transfers from the EU which help address deepening market concerns about sustainability of its huge debts. Without these, the crisis will simply be deferred.

The message is clear: Greece's debt load at Eureo 350 billion or 150% of its expected economic output this year, is simply too large for the EU troika's (plus ECB and IMF) strategy to succeed. Athens had accepted a package of Euro 110 billion of EU/IMF loans in May 2010. But it now needs a 2nd bailout of a similar size to meet financial obligations until end 2014 when it hopes to move seamlessly into the new ESM (European Stability Mechanism) bailout fund (which takes effect in 2013) to prop up fiscal miscreants.

Latest draw-down involves release of a vital Euro 12 billion very soon but carries a proviso that parliament passes on June 29 (which it did with a slim majority) Euro 28.6 billion in spending cuts and tax increases as well as Euro 50 billion from privatisation of state assets, in addition to continuing existing austerity policies.

That's not all. The new plan calls for private creditor's participation on a voluntary basis (meeting ECB's insistence to avoid even a hint of default) or “Vienna Plus”, a reference to the 2009 Vienna initiative where banks agreed to maintain their exposure to Eastern Europe.

For Greece, the brutal austerity plans call for enormous sacrifices; indeed, no end to their agonies. Today, the situation at Syntagma Square and in front of parliament is getting more strained, angry and confused, surrounded by riot police and clouds of teargas. The people are becoming frustrated at being always at the receiving end.

On the German side, however, voters are aghast at the prospect of a 2nd bail-out, which they regard as pouring good money after bad. Germans consider the Greek government as corrupt; its tax system operates on voluntarism; state railroad's payroll is 4 times larger than its ticket sales; many workers retire with full state pension at age 45; etc.

Be that as it may, the IMF in particular needs to learn from lessons of the Asian currency crisis, where it has since acknowledged its prescriptions at the time made matters worse in Indonesia, Thailand and the Philippines, in the name of unleashing market forces to force adjustment and ignoring the adverse social and political impact of their policies.

I see them repeating the same mistakes again in Greece, paying too little heed to human suffering and adverse social impact to protect private sector creditors and pushing the end-game at breakneck pace. Germany's insistence to get private creditors share in the burden is a good soft step forward. Even so, the IMF seems too harsh.

Few options left

The fact remains Greece was outstandingly egregious in its fiscal profligacy and its lack of prudent economic governance. But Greece was not the only European economy that was living beyond its means and being pumped withill-conceived loans mainly from German and French banks. Greece is today insolvent. The EU's solution addresses only immediate funding needs, without offering a credible long-term resolution. It's just a stopgap. Frankly, Greece'spolicy options are limited: either a default, partial haircut (creditors taking losses on their investments), or a guarantee on Greek debt. Bear in mind Germany remains the biggest beneficiary of the euro-zone experiment. In 2010,

Germany recorded a US$185bil balance of payments surplus or 5.6% of GDP. No doubt, the EU has since pledged to stabilise the euro-zone economy, vowing to starve off a Greek default, and the ECB has categorically ruled out debt restructuring. That leaves Greece with only deflation, a lot of it.

As I see it, this will not work. First, in a democratic Greece, people are clearly not in the mood for deeper spending cuts and more austerity. Policies can be adopted but they can fail. Second, deflation had already made Greece's debt problem worse the debt is too large and the economy won't grow with continuing deflation. It can't just deflate its way to solvency.

The better option left is debt guarantee. Issuing guarantees (preferably partially backed by Greek assets) could help persuade creditors to exchange debt for new debt with longer maturities, effectively giving Athens more time to repay. As of now, only 27% of Greek debt is held by banks, 30% by ECB/EU/IMF, and 43% by other privates. Banks are already quietly resisting voluntary rolling-over unless offered incentives. EU has preferred to use moral suasion.

EU has also resisted haircuts. Mr Axel Weber, former Bundesbank governor, has since weighed in: “At some point you've got to cut your losses and restart the system,” drawing parallels between guarantee for Greek debt and steps taken by Germany and others during the financial crisis to backstop troubled banks.

The Greek problem “is a deep-rooted fiscal and structural problem that probably needs more than a 30-year time horizon to solve. The measures Europe need to adopt are much more profound than just short-term liquidity funds.” That, of course, raises the issue of “moral hazard”. EU has since pledged to stabilise the euro-zone, and starve off a Greek default in exchange for continuing Greek deflation and voluntary creditors' roll-over. Getting banks to share in the burden remains problematic. But, a narrow policy option is taken. It's another muddle-through created in response to politics. It offers no long-term way for Greece to resume growth.

I am told the political mood in Greece improves automatically in July and August as the urbans head en masse for family villages in the islands and mountains. Surely, for a little while, human woes will be eased by exposure to the beauty of the Agean.

Former banker, Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome at starbizweek@thestar.com.my

US Dollar’s Share Of Global Reserves Continues To Slide, Reserve Status Questioned

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Dollar’s Share Of Global Reserves Continues To Slide, Reserve Status Questioned

 Timmy Geithner and Bennie Bernanke have contributed to the dollar's decline - Getty Images North America.

WASHINGTON - APRIL 21: Treasury Secretary Timothy Geithner (L) and Federal Reserve Chairman Ben Bernanke applaud during the unveiling of the new $100 note in the Cash Room at the Treasury Department April 21, 2010 in Washington, DC. According to the Treasury Department, the U.S. government evaluates advances in digital and printing technology to redesign currency and stay ahead of counterfeiters. The new note will be put into circulation in Feburary 2011.

Further confirmation that the U.S. dollar is gradually losing its reserve status came today from an International Monetary Fund report on global holdings of foreign exchange reserves by central banks.  The greenback, and the euro, lost share vis-à-vis the Japanese yen, the Australian, and the Canadian dollar, pointing to a “slow, gradual diversification” of reserve holdings.

With Christine Lagarde recently appointed General Manager in replacement of the disgraced Dominique Strauss-Kahn, the IMF released its latest “Composition of Official Foreign Exchange Reserves” (COMFER) which lists reserves held at central banks in 33 “advanced economies” and 105 “emerging and developing economies.”  China, one of the largest holders of foreign reserves, is not included in the sample. (Read IMF Appoints Lagarde To Fix A Disgraced institution).

Attesting to the continued global loss of confidence in the U.S. dollar, the greenback’s share of the world’s reserve continued to slide in the fourth quarter of 2010, the latest data show.  Interestingly, the trend can be explained entirely by valuation effects, with the trade-weighted dollar depreciating 4%% in that time frame.

The U.S.’ share of allocated reserves fell in the first quarter to 60.69%% from 61.53% from Q4 2010.  Central Bank reserves move slowly, but the slide in the greenback’s share, which Nomura suggests would be even steeper if China was included in the sample, has been very pronounced if one takes a longer-term window.



A year before the latest data, Q1 2010, the greenback’s share stood at 61.64%, while in Q1 2001, ten years before, it stood at 72.3%.  While USDs dominance was unquestioned a few years ago, it is anything but rare to speak of a move toward a multi-currency system, with the dollar still a primus inter pares [first among peers]. (Read Central Banks Dump Treasuries As Dollar’s Reserve Currency Status Fades).

Emerging and developing nations aggressively accumulated foreign reserves in the first quarter, as their high-growth economies attracted massive capital flows from so-called advanced economies.  While rich nations added $65.5 billion in reserves, $1.6 billion of those in U.S. dollars, emerging markets added $366.3 billion, $65.8 billion of those in dollars.  Regardless, EM central banks also sought further diversification, with the Japanese Yen as the main destination.

Emerging market central banks accumulated $6.6 billion in new JPY reserves in the first quarter, taking their allocation up to 2.9%.  “While the increase appears small, it signifies that the yen has recently found favor amongst EM central banks as an alternative safe haven,” noted Nomura.

“Other” currencies, as denominated by the IMF, made up 20% of emerging market reserve accumulation in the first quarter.  With the Canadian and Australian dollars as some of the biggest beneficiaries, the share of “other” currencies climbed up to 5.8%, from 5.1% in Q4 2010.

Euro share of global reserves crawled up a couple of percentage points to 26.6%, despite being shunned by EM central banks (where its share fell to 28.2%).  With the euro gaining 5.8% against the dollar in the first quarter, the data indicates EM’s actively selling euros.  “It is likely that central banks sought to rebalance their reserve portfolios in the wake of EUR strength and corresponding USD weakness. That is, they sold EUR and bought USD and other currencies to counter the sharp change in valuation,” explained Nomura’s analysts.

The IMF’s most recent COFER continues to support the thesis that the U.S. is losing its reserve status.  Central banks are sticking to “relatively stable allocations of major currencies,” namely the U.S. dollar and the euro, yet they are gradually moving away, adding yen and “other” currencies.  While the greenback will continue to play a predominant role in world trade, there can be no doubt that slowly, but surely, central banks will rely less and less on it.

Why the US is the greatest threat to Lagarde at the IMF?

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"It's a victory for France," President Nicolas Sarkozy said of Christine Lagarde's appointment as the new head of the International Monetary Fund.

Christine Lagarde leaves a private TV studio after appearing on prime time news in Boulogne Photo: REUTERS

By Richard Blackden, US Business Editor

It should come as no surprise that the unpopular French leader is trying to put a positive spin on losing his highly-regarded finance minister. And, in one sense, Sarkozy is spot on.

Lagarde becomes the IMF's fifth French leader, and her appointment ensures that the Gallic republic keeps a powerful voice at an institution that has made a comeback thanks to the financial crisis. But Lagarde won't have appreciated her former boss airing his sentiment in public. The 55-year old will start her first day in the job next Tuesday with three question marks hanging over her appointment.

The first and least troublesome one is some inevitable concern within the IMF that she's not an economist. Lagarde trained as a lawyer and spent 25 years working at US law firm Baker & McKenzie before moving into politics in 2005. Some of this will be intellectual snobbery, but some will be legitimate concern over whether she's qualified for the job. She's regarded as highly intelligent and the fund already has an army of economists that matters can be delegated to.

The second is whether her selection was a stitch up. And it was. Europe still wields a disproportionately large amount of votes at the IMF's top table - a gift from history that the continent is understandably reluctant to relinquish. There's nothing she can do about that, and Lagarde has already pledged to make changes to the voting system so it better reflects the shifting balance of economic power in the world.

The third is by far the most serious. As the French finance minister intimately involved in Europe's debt crisis during the last 12 months, will she be able to give the IMF an independent voice and protect the interest of its creditors? Lagarde certainly thinks so. During her job interview last week she told the IMF's Executive Board that "I will not shrink from the necessary candour and toughness in my discussions with European leaders." Adding that "there is no room for benevolence when tough choices must be made."

The former lawyer spent much of the past month visiting China, India and Brazil to assure them that she will not throw good IMF money after bad to solve Europe's debt dilemma. The fund, which means its donors, is supplying about a third of the €110bn that was pledged to Greece as part of the first bail-out in May, 2010. Such assurances appear to have won over those three economic heavyweights, who declared for her rather than Agustin Carstens, the head of Mexico's central bank, and Lagarde’s only rival.

Victory, though, only came when the Obama administration threw its weight behind Lagarde this week. US Treasury Secretary Tim Geithner sang the praises of his former counterpart and new neighbour in Washington DC. But it's politicians in the US capital, rather than Beijing, Delhi or Sao Paulo, that pose the greatest threat to Lagarde.

Despite the warm and no doubt genuine words from Geithner, The White House is increasingly frustrated at Europeans' handling of their own debt debacle. Its latest flaring comes as the US economic recovery is losing momentum, and Obama is trying to wrestle back the political initiative from a Republican party emboldened by the recent US slowdown. The irritation was likely behind an unusual public rebuke to European leaders from Geithner last week when he said it would be better if they could speak with one voice.

A still bigger threat comes from Congress. The Obama administration struggled to push through an extra $108bn in funding for the IMF in June 2009. If bail-out was a toxic word in Washington then, it has only become more so since. So far the contributions from the IMF, where the US is the biggest single donor, have raised relatively few heckles in the House of Representatives or Senate. But with Republican candidates currently vying for the right to challenge Obama next year, the chances are that will change. And any money required from the IMF for Greece's second bail-out will receive far more political scrutiny in the country that will have to dig deepest into its own pockets.

It's to her new neighbours in Washington, more than anyone else, that Lagarde needs to prove that her appointment is no victory for France.

Debt-consolidation plans vital

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MAKING A POINT By JAGDEV SINGH SIDHU

IT'S easy to picture the worst when the news around us is not savoury at all.

The platter for such troubles will include the second-quarter slowdown induced by the earthquake and tsunami in Japan. Output around the world has been shaken by the ramifications of the supply shock from Japan.

Then there is the report card on the US Federal Reserve's second round of quantitative easing (QE2). For many, QE2 really did not help the foundation of the economy. Unemployment is still sticky and there is still weakness in the housing sector but the stock market and commodities boomed with cheap liquidity flooding the market.

Inflation jumped as raw material prices surged and that, in effect, robbed a lot of people of purchasing power.

Looking at Greece, one has to assume a default is a certainty and is just a question of time. In fact, the CEO of Pimco, the world's largest bond fund, expects that to happen and many, too, agree looking at the economic structure of Greece.

Despite the gloom, the prognosis for the global economy really has not changed much.

The International Monetary Fund (IMF) expects the world economy to grow by 4.3% for 2011, which is 0.1% lower than previously estimated.

It has cut its growth forecast for the United States to 2.5% in 2011 from an earlier estimate of 2.8% in April.

IMF's Olivier Blanchard, who is its economic counsellor and the director of the research department, said predicting the economic direction for the US was too early but felt the slowdown of the US economy was more of a bump on the road than something worse.



“But assuming that oil prices are going to stay roughly stable, which is what the markets seem to predict at this point, we think that spending by consumers and firms should remain steady in what is, however, very clearly a very weak recovery. This has been a longstanding forecast of ours. The recovery in the US is a very weak one,” said Blanchard last week.

The outlook for Japan saw the biggest change as the earthquake and tsunami are expected to see that economy contracting by 0.7% this year from an earlier forecast of a 1.4% growth made in April.

The IMF has stuck to its projections for the two most populous countries, estimating growth for China and India to register 9.6% and 8.2% respectively this year. Those estimates were unchanged from April.

With troubles in Greece hogging international financial news and people wondering about the repercussions of a default by Greece on financial institutions in Europe and the US, the IMF said the risk of contagion was real and could derail European recovery and even that of the world but thought advanced economies, in which Europe features prominently, was forecast to grow at 2.2% for 2011, down 0.2 percentage points from earlier thought.

Its forecast for emerging and developing economies is 6.6% for 2011, which is up 0.1 percentage points since April.
While forecasts are relatively flat, the IMF did say risks were visible and highlighted the debt issue not only in Europe to be one of the hazard points for the global economy.

It feels debt-consolidation plans, even in the US, needs to be in place for the medium term to avoid higher borrowing costs and slower economic growth in the future.

In Asia, asset and price inflation are seen as the key risks and it feels countries with large current account surpluses should allow their currencies to appreciate.

“All countries must choose the right combination of instruments at their disposal fiscal, monetary, macro prudential to slow their economies in time and avoid costly boom-bust cycles,” said Blanchard.

Whether the bad news translates to most people's economic nightmare is something most businesses and investors are keeping an eye out for. It would appear that, for now at least, prospects and risks are balanced.

Deputy news editor Jagdev Singh Sidhu has filled nearly every large container at home with water to prepare for a dry couple of days but water is still flowing strongly from the main pipe.