Janelanaweb interviewed Bertrand Candelon, Professor in International Monetary Economics, Department of Economics of Maastricht University School of Business and Economics.

Interview by Jorge Nascimento Rodrigues (a) 2011

The answers from Dr. Candelon do not engage his co-authors, neither the institututions he is consultant for (IMF and European Commission).

Highlights
« It is thus very unprobable that Portugal will default stricto-sensu.»
« This downgrade decision would affect the other European countries as well as Portugal itself potentially creating a vicious circle»
«If you think about the idea of creating a European CRA (as it was the idea of the European commissaire Michel Barnier), I think it would make sense.»
« Another possibility may be to make the ranking more continuous (i.e. increase the number of ranking classes). The decision to downgrade of a notch should then become less important for the financial stability. Such a controle (I prefer this term to regulation) might be desirable.»

Q: The paper you co-authored clearly refers a systemic impact from the downgrades to near-junk in the case of Greece in the past. Do you think we can have a similar impact now with the case of Portugal and the risk of a downgrade of Ireland from A- to B status after the stress tests of tomorrow?
A: Yes. I think it is probable especially if Ireland is downgraded again. It looks like the Greek downgrade near to junk we have in the paper. My strongest fear at the moment is related to Spain because of the financial amount it represents (difficult to bail out). Stronger downgrade may create a big one shock. Let’s hope it will not be the case.

Q: These recent downgrade movements from the main rating agencies regarding Portugal are justifiable?
A: Let us first remember the objective of a credit rating agency. Rating should indicate for investors the long run economic perspective of the country. It means that they should avoid to modify the rating across the cycle or after any temporary shock. In the case of Portugal, a downgrade would thus mean that the public finance situation becomes critical and is less sustainable in the long run. Foreign investors are thus exposed to higher risk when lending to Portugal. The downgrade is justified if it is the case. Everybody is aware that the fiscal and political situation in Portugal as in Greece is critical in many ways. Nevertheless, 2 arguments may go against the downgrade: First, European Union (alone or with the IMF) has the capacity to bail-out Portugal as Greece (which would not be the case for Spain). It is thus very unprobable that Portugal will default stricto-sensu. Second, as we show in the paper downgrade has an impact on financial markets (pushing down the stock market global and subindices and increasing the CDS rate), that would 1) affect the other european countries as well as 2) Portugal itself potentially creating a vicious circle. In other words, even if Portugal situation is becoming unsustainable in the long run instead of solving the problem, it will add to the financial instability in Portugal and in the whole Europe. The solution will come from the economic side.

Q: In the rating agencies industry, do we need a global diversification of these type of companies?
A: We must realize that CRA [credit rating agencies] are independent firms, with benefits and market positioning. The market is actually oligopolistic and composed by S&P, Moodys and Fitch. So it may be that to get credibility, a CRA decides to lead the sequence of downgrades. For example in the case of Portugal, Moody’s was the first to downgrade followed by Fitch and then S&P. To this respect, one idea would be to create new CRA aiming at creating an efficient rating world. Potential problems may be that 1) it may take some time before a new CRA gain enough credibility on the market to compete with the existing ones, 2) it will not prevent fron selffulfilling mechanisms (a sequence of actions disconnected fundamental factors) and 3) if the country is really suffering from long-run economic problem a simultaneous downgrade of all the CRA will have huger effect on financial stability. Besides in our paper which covers the period 2007-2010 we only find weak evidence of such sequence.

Q: Europe must have companies of this type, like China and Canada has?
A: First, I am not familiar with the CRA organization in China or Canada. If you think about the idea of creating a European CRA (as it was the idea of the European commissaire Michel Barnier), I think it would make sense. 1) it will increase the information space (in Asia 6 CRA are coexisting) and 2) lead the other CRA to focus more on the long-run. Nevertheless, it has to gain sufficient credibility and also to be somehow independent from the political authorities: After all if a country is running unsustainable macroeoconomic policy in the long-run it has to be downgraded, whatever the potential consequences, this is the duty of CRA.

Q: Is it citicial do regulate this industry, regarding what happened during the bubble times?
A: Again the role of a CRA is to rate according the long-run economic situation of the country. Nevertheless, as 1) this objective is debattable and 2) a rating change have huge consequence on financial markets in the downgraded country but also elsewhere, I think some regulation may be wishable. But how to do that? A first idea could be to supervise the models from which the rating are issued to insure they focus exclusively on the long-run. It could be for example feasible to create a European label for the rating model (without making them public of course). Another possibility may be to make the ranking more continuous (i.e. increase the number of ranking classes). The decision to downgrade of a notch should then become less important for the financial stability. Such a controle (I prefer this term to regulation) might be desirable.

Q: Most of the critics of the rating agencies’ recent movements in the sovereigns (downgrading Greece, Ireland and Portugal) didn’t speak against when the same agencies rated AAA or almost the same countries in the bubble epoch, fueling the credit bubble. Would you comment this?
A: Indeed, this is the symmetric problem and the proof that they were rating trough the cycle. A long-run analysis would have revealed that these countries were in a bubble, meaning that in the long run it will, for sure, explode. In such a case, a downgrade or at least a negative revision could have expected. Again, I do not say it would have avoid the explosion of the bubble but it may have limited its volatility.

Recent rating notes from CRA
Last week for Portugal from A- to BBB
March 29 for Portugal from BBB to BBB- (this is similar now to Hungary and
Iceland)
March 29 for Greece from BB+ to BB- (both “junk” status)
April 1 for Ireland from A- to BBB+

Moody’s about Portugal
March 16 from A1 to A3

Fitch about Portugal
March 24 from AA to AA-
April 1 from AA- to BBB-

The other peripheral, not changed recently by S&P
Italy: A+
Spain: AA

A virtual roundtable with 5 economists and financial analysts edited by Jorge Nascimento Rodrigues
© janelanaweb.com and contributor for Expresso Portuguese weekly newspaper, April 2010

Topics

. Portugal is a  Greece number two?

. What can Portuguese Government do to invert the risky near-default situation?

. The Euro zone risks a serial default wave?

. Greece must default and opt out from the euro?

. This turmoil is a failure of the European Monetary Union (EMU)?

. An European Monetary Fund (EMF) would be useful?

See PORTUGUESE PROFILE (Main figures Portugal and Greece Benchmark) at the END of the Roundtable

VIRTUAL ROUNDTABLE (April 28)

MARK THOMA (Univ. Oregon): « I think it is possible to invert the situation with poor policy choices, so the trick is to get policy correct»

1. The difficulty Portugal faces is due to its inability to implement the monetary policy it needs. Without such ability, the adjustment is on the real side of the economy – e.g. employment and output – and there simply aren’t any good choices. Thus, the government’s job is to minimize the painful adjustment that likely lies ahead, not an easy job.

2. I think it is possible to invert the situation with poor policy choices, so the trick is to get policy correct. That requires a unified approach to the problem that does not appear to exist, so the danger is there.

3. The stress is revealing the weak points in the euro system, e.g. the inability to use independent monetary policy to address financial problems. I’m not yet convinced that the union is in trouble, but the risks are clearly higher than I would have thought not all that long ago.

4. I think that a European Monetary Found would help. Unfortunately, it is difficult to create new, functional institutions while a crisis is underway so something like this could help next time, but it can’t help presently.

PETER COHAN (Peter Cohan & Associates, Boston): «It’s possible a serial default but not likely. »

1. It helps to look at some numbers and ratings.  Greece’s government bond rating is in junk territory with a budget-deficit-to-GDP ratio of 13,6%. Portugal is in better shape — S&P lowered Portugal’s credit rating two notches to A- which is still pretty good and it has a lower budget-deficit-to-GDP ratio of 9.4%.But there is growing concern about Portuguese debt. The gap between the yield on that Portugal’s 2-year notes rose to 4.3 percentage points above comparable German debt from 3.1 percentage points Monday. A week ago that spread was at 1.4 percentage points. It would take $53 billion to bail out Portugal and $120 billion to do the same for Greece.

2. I guess the Portuguese government could announce a major deficit reduction plan with specific targets and a schedule to repay debt early.

3. It’s possible a serial default but not likely.  I think some combination of the healthier EU countries and the IMF will step in to keep that from happening.

4. If it was just a matter of economics, it would be better for Greece to default and opt out.  But for political reasons which I do not understand, there seems to be an enormous barrier that blocks that logical, but painful move from happening.

5. To me this turmoil it’s a classic case that is similar to what happened during the financial crisis in the U.S.  The fiscally conservative members of the EU end up being punished for being sound while the ones who borrowed more than they could repay and hid that fact end up being rewarded by the healthy ones. I think that the EU admitted members who did not meet its standards of fiscal health for political reasons that I don’t understand and now those members could bring down the entire edifice.

6. There are two options: let the free market work – in the sense of culling the weak and letting them fend for themselves or punish the prudent by demanding that they bail out the countries that can’t repay what they owe.  If the EU survives this crisis with the same membership, it will be necessary to create some kind of insurance fund that can deal with such problems when they recur.  But who will pay for it?

BILL WITHERELL (Cumberland Advisors): « The Portuguese government has been following much more responsible steps to resolve the problem and international investors should recognize this difference. »

1. Portugal is not Greece. It has a difficult but different debt situation. A considerably larger share of its overall external debt is private sector debt. The Portuguese government has been following much more responsible steps to resolve the problem and international investors should recognize this difference.  Portugal’s situation is being seriously worsened by contagion from Greece, which is indeed an irrational over-reaction. But the underlying situation has worsened as a result as refinancing costs have soared. That has to be a major factor behind the downgrade.

2. The Portuguese government will have to resolve to take additional fiscal restraints and also to tackle more aggressively structural reforms that will help the economy become more competitive internationally.

3. Several defaults are not impossible. What I think is increasingly likely is a restructuring of Greece’s debt, with some capital loss. That should not be necessary for Portugal or Spain unless the loss of investor confidence gets significantly more severe than it has to date.

4. Other Members certainly should not force Greece to default (as that would have a heavy impact on other Members) nor force Greece to “opt out” – which would mean Greece leaving the EU. As I understand it, they cannot simply opt out of the Monetary Union. A Monetary Union without Greece would appear to be a stronger currency, but the political ramifications of such a process being forced on them could do severe harm.

5. This turmoil is a symptom of fragility, demonstrating the need for reforms that will result in stronger coordination and discipline in the area of economic policies. While Greece is the most flagrant in this area, along with (intentionally) providing unreliable data, most other EMU members have also slipped in the past in one way or another.

6. While a European Monetary Fund might be useful, I do not think it is necessary as long as members are willing to make use of the International Monetary Fund which has been established to deal with such problems.

DAVID CAPLOE (Economy Watch, Singapore): «The Portuguese government might, again PUBLICLY, request the rating agencies like S & P to make clear and open the criteria they are using to make their ratings — especially when they are compared to other, more advanced countries whose statistical profile is similar to Portugal, but whose rating they have NOT downgraded. »

1. There are obviously some sovereign debt similarities — but we certainly don’t know the extent to which, or even if, firms like Goldman Sachs were involved in the Portuguese situation, as they clearly were with Greece. And that definitely makes a difference from a general stability point of view. That said, the debt / GDP ratios of the two countries are also different, although Portugal’s is, unfortunately, trending in a negative direction. Still, Greece’s is well above 100% and Portugal’s well under, so while I agree there’s a disturbing trend in Portugal’s sovereign debt situation, I don’t think the situations are structurally analogous at all. As for the market‘s reactions, well, we just ran an excellent piece from a German analyst who pointed out quite clearly how market speculators thrive on political ambiguity, of which Germany’s Angela Merkel has, unfortunately, contributed an outsize portion to the Greek situation.

2. Well, far be it from me to tell the Portuguese government how to handle a VERY tricky and dynamic situation — there are NO easy or clear answers. What I would suggest is that they PUBLICLY request the ECB / IMF / and other Euro-zone institutions to put a hold on obvious speculator / hedge fund plays on Portuguese debt for the next two weeks — similar to what the Greek government has done in banning “shorts for the next two weeks — until there can be a little more order and predictability in the entire situation. Beyond that, I don’t think there’s much they CAN do except wait for the otherwise seemingly inevitable onslaught of the speculators. In that context, though, they might, again PUBLICLY, request the rating agencies like S & P to make clear and open the criteria they are using to make their ratings — especially when they are compared to other, more advanced countries — if, indeed, there are any — whose statistical profile is similar to Portugal, but whose rating they have NOT downgraded. Indeed, I think it’s high time a little focus is put on the rating agencies themselves whose record is anything BUT blameless in this on-going disaster.

3. It’s POSSIBLE to have BOTH a “true default” AND a serial default within the Euro-zone. As we have continually pointed, there is a structural problem in the Euro-zone, which could be papered over as long as the global and European economies were doing well, but which became painfully evident in the aftermath of Black September 2008 and the lending freeze imposed by the Too-Big-To-Fail US banks, that immediately created what we now refer to as The Great Recession. So, unfortunately, BOTH of these are real possibilities, ESPECIALLY as long as the political leadership of the Euro-zone as a whole, and the major individual countries — above all, of course, Germany — remain unable / unwilling / unclear about how to make sure such defaults DON’T occur.

4. I can’t see ANY scenario in which forcing Greece out of the Euro-zone does ANYTHING but heighten the crisis, and make it worse for everyone — most particularly, the “next” such countries, namely Portugal, Spain, and — hold your breath — Italy, which was one of the original EEC 6 back in 1959. The default of Greece, and its expulsion from the Euro-zone — again, especially in the crass and chaotic way in which it would have to be done … IF it were to be done — would really throw the entire project into question. And while there are certainly problems with keeping the Euro-zone together — above all, bringing the fiscal, i.e., government spending, policies of ALL the countries into line, just as has occurred at the monetary level — dealing with those problems are INFINITELY preferable to letting the Euro zone collapse a) at all, and b) in such an undignified and uncontrolled fashion. There are also just too many real economic links among the Euro-zone countries to make such a de-linkage even thinkable, so, as Paul Krugman correctly said when this crisis first emerged, there really is no way to go but forward.

5. Certainly the fragility, as we have noted, and of a structural problem within the Euro-zone, namely, as above, the conflict between a single monetary policy formulated by the European Central Bank, and fiscal, or government spending, policy, which remains in the hands of the 16 member countries, and which, to be sure, they are going to be VERY reluctant to cede to ANY sort of “supreme” power. Now this is NOT a problem that can any longer paper over, as it was until Black September 2008, and there are neither immediately visible, let alone easy, solutions to this problem. Nevertheless, as we have noted, Europe as a whole — not just the Euro-zone — HAS become deeply unified by real economic links that ARE working, and which DO contribute to a genuine European solidarity. So while I think this DOES represent a structural crisis within the Euro-zone, I ALSO think there are counter-veiling forces to keep the zone together, and I think the test of real leadership — which, to be honest, has been sadly lacking in the current generation of European and, to be honest, American, political leaders as well — is whether they can find a way to BUILD on this genuine REAL ECONOMIC inter-connection to solve this problem between fiscal and monetary policy. It certainly won’t be easy, but it CAN be done — IF the leaders involved act like such, and have the VISION to use the existing base to solve admittedly difficult problems.

6. I think a European Monetary Fund (EMF) probably is necessary, and I don’t think it’s a bad thing for such a body to be created, especially as part of a transition from a situation of 16 fiscal policies vs. 1 monetary policy to whatever else may take shape. The IMF has plenty on its plate already, and, while it does seem a necessary part of an immediate solution to the Greek situation, I think neither it nor Europeans really WILL be comfortable with it being a permanent feature of the European political economic scene. So I think that an EMF is a very good idea, one whose creation could engage European creativity of the sort that oversaw the creation of the European Coal and Steel Community in the mid-50s, and then the European Economic Community, and return to the convertibility of European currencies, at the end of 1958. Obviously, the “deals” that will have to be made will be a bit more complex than those — which basically secured French markets for German industrial goods, and German markets for French agricultural goods — but I don’t think it should be beyond the capacity of Europeans to create such a body to help ease the inevitable strains of transition from 16 fiscal policies to somewhat fewer, even if not yet a single one.

GARY DYMSKI (Univ. California): « But if Europe fractures, then it’s every country for itself, and the nations with weaker positions will indeed have to adjust more – and will be riskier from a ‘solvency’ viewpoint – in future years.»

1. Portugal’s situation and that of Spain resemble the situation of Greece in some ways – for example, fiscal deficit as a share of GDP, trade balance, and so on. The fact that these Southern European nations have “structural deficits” on trade and on government expenditure is not surprising when we consider the overall structure of production and trade within the Euro area. High-productivity production and export capacity is monopolized by Germany and France, and lower-wage production and export capacity by other portions of the periphery of Europe. If a balance-sheet of Europe is drawn up, these national “problems” disappear in an overall picture of Europe’s strength. But here there is a catch-22. If Europe remains strong, then the markets will evaluate Europe as a whole, thinking of individual nation-states as part of this entity. But if Europe fractures, then it’s every country for itself, and the nations with weaker positions will indeed have to adjust more – and will be riskier from a ‘solvency’ viewpoint – in future years. But this raises the question of what is Europe? Is it the Euro? Is Germany being so cautious because it doesn’t want to set a precedent? Claro! But if Greece is given an unworkable deal that will fail, why should the markets believe there is any better future ahead for Portugal or Spain?

2. The Portuguese government has to mobilize on three levels: it has to work with other threatened nations to come up with common goals and ideas; it has to work within the Euro framework on behalf of the threatened nations, and it has to mobilize the population to fight for a decent standard of life and the maintenance of a real social safety net.

3. I think it is possible to imagine a scenario of serial defaults. We are seeing no political will for more creative solutions in Germany or France at the moment; the UK has a stagnant, wounded economy and is a by-stander; the US has a stagnant, wounded economy and has its own issues; and China is trying to outrun a housing bubble.

4. As I suggested, I think the nations that are being targeted by speculators have to come together to share ideas and come up with a common set of plans and proposals. In other words, Portugal and Spain, at the very least, must talk with Greece about the default/opt-out scenario and show some solidarity. For Portugal or Spain to side with Germany against Greece would be suicidal for the vision of  “one Europe.” What is needed now is a strong, clear, honest conversation about what “one Europe” means in the post-neoliberal world.

5. The turmoil in Europe represents the collision between the collapse of the conditions for continued accumulation under neoliberal conditions (financialization, market liberalization, race-to-the-bottom export-led growth, etc.) and the rules that were established for the Euro zone (in particular the Euro, the regulation of European banks, and European fiscal/monetary policy coordination. The Euro zone rules were adapted for a world of zero-sum tradeoffs wherein one country’s ‘win’ is another’s ‘loss’. That was the theme for growth in the neoliberal age; only the structural imbalance that permitted the US and to a lesser extent Northern Europe to act as “consumers of last resort” provided any scope for growth in that world. But that growth was, of course, based ultimately on a very fragile basis – and then, as we know, it collapsed.

6. From what I’ve suggested, Europe needs to rethink the terms and conditions of its union, and this means at core the institutional mechanisms it has available to resolve problems. It was assumed in putting Europe’s current rules into place, that Europe’s strength could be maintained only by disciplining those countries too weak to discipline themselves. The liberalization of markets that also accompanied the Euro zone, plus the actions of deregulated banks, created a situation in which structural imbalances unimagined previously came into existence. So simple discipline will not do any more. The conversation ultimately involves a very basic question, which no politician is prepared to answer: “What human rights and economic protections does a person have a right to, if that person is a European?”  Politicians in France answer that question regard the French; in Germany, regarding the Germans; etc. But not for Europe as a whole. And within each country, indeed, there are questions about “who is French?”, “who is German?” etc., that lead in very troubling directions. Indeed, in the end we have this question, “What human rights and economic protections does a person have a right to, given that that person is a human being?” In the end, the only end to this global crisis will come when we are ready to face that question. Until then, we live in the twilight.

PORTUGUESE PROFILE (Benchmark with Greece)

GDP 2009 (IMF list): $227.9 bn (Greece: $330.8 bn)

Population (Jan.2010): 10.6 m (Greece: 11.3 m)

GDP per capita PPP (2009): $21,859 (Greece: $29,882)

Average projected real GDP growth rate 2010-2011 (IMF/WEO): 0.47% (Greece: -1.53%, recession)

Unemployment rate: 10.8% (Greece: 10.2%)

Gross National Saving as % of nominal GDP (2009, National Accounts OECD): 8.1% (Greece:7.7%)

Refinancing needs for outstanding bonds 2010-2012 (Monthly Bulletin, IGCP, May 2010): €40,1 bn (Greece: €123 bn)

Direct Public debt ratio to GDP (2009): 77% (Greece: 115%)

General Government Gross Debt ratio to GDP (2009): 77.2% (Greece: 113.4%)

Public deficit ratio to GDP (2009): -9.4% (Greece: 13.6%)

Projected General Government structural deficit ratio to GDP (2010): -7.1% (Greece: - 8.9%)

Projected public debt ratio to GDP in 2012: 90.7% (Greece:148.8%)

Difference from boom to bust: 3.1 (Greece: 9.9)

Impact of fiscal adjustment on output relative do baseline: -5.3% (Greece: -24.8%)

Total Gross External Debt as % GDP (2009): 225% (Greece: 168.2%)

Net External debt position as % of GDP (2009): 88.6% (Greece:82.5%)

Total Gross External Debt as % Exports (2009): 817% (Greece: 832%)

Gross External Liabilities as % of GDP (2009): 281.5% (Greece: 188.4%)

Government gross external debt as % tax revenue (2009): 189% (Greece: 329%)

General Government net external debt as % of GDP: 74.9% (Greece: 78.9%)

Net International investment position as % of GDP (2009): 111.7% (Greece: 82.2%)

General Government debt hold abroad as % GDP (2009): 60.2% (Greece: 99%)

Projected Current account balance as % GDP (2010): -8.6% (Greece: -7%)

Projected Budget Balance as % of GDP (2010): – 7.9% (Greece: 10.2%)

Deterioration of the Real Effective Exchange Rate (1999-2008) based on the Nominal Unit Labor Cost of total Economy: 15.9 % (Greece: 12.4%)

Deterioration of the Real Effective Exchange Rate (1999-2008) based on the Nominal Unit Labor Cost of Manufacturing:  13.6% (Greece: 24.4%)

BIS Reporting banks consolidated claims on public sector as % GDP (2009): 23% (Greece: 32.3%)

Rating sovereign debt (S&P, April 2010): A- (Greece: BB+, junk status)

Peak CDS cost (April 27, 2010, daily close numbers): 385.89 basis points (Greece: 823.72 bp)

Peak Compound Probability of Default (May 6, 2010, daily close numbers): 32.63% (Greece: 52.61%)

European Banks exposure to Portuguese Debt: $244 bn (Greece: $206 bn)

Interest Rates 10-year government bonds (June 10, 2010): 5.23% (Greece: 8.15%)

Defaults in the recent past: 4 events – 1828; 1837; 1850; 1892 (Greece: 4 events – 1826; 1843; 1860; 1894)

Time Horizon to revert to a “bearable” public-debt level of 60% of its respective GDP (IMD Debt Stress test): 2037 (Greece:2031)

Sources: IMF GSFR 2010 (April); Daniel Gros and Alcidi Cinzia (VOX, April 23, 2010); S&P (April 27, 2010); CMA DataVision; IMF World Economic Outlook 2010 (April); FT Deutschland; IMF General Statistics; This time is different Chartbook 2010, NBER, Carmen Reinhart; Bloomberg BusinessWeek, April 29,2010; IMD Debt Stress test, IMD May 19, 2010, IMD World Competitiveness Center; BIS Quatertly Review (June 2010); The PIGS’ External Debt Problem, Ricardo Cabral (VOXeu.org, May 8th,2010); The Economist, June 10th, 2010; Current Account Imbalances in the Southern Euro Area, Florence Jaumotte and Piyaporn Sodsriwiboon (IMF, Workong Paper 10/139, June 2010).

The present program inspired in IMF core ingredients will cost 1.5 to 2 points in the growth rate. But the financial markets – particularly the sovereign credit default swaps market – and the political fights inside the European Union core countries didn’t give a hand to Prime Minister George Papandreou.

In the domestic front, the socialist government has a complex political problem: “Greek society is not yet prepared for nor convinced about the merits of this odyssey. The government must establish new alliances, hold its ground and above all explain towards an unconvinced population why it is necessary to urgently change course.”

A PROFILE

Jens Bastian is senior research fellow at ELIAMEP- Helenic Foundation for European and Foreign Policy, based in Athens, Greece. Born in Germany, he is living in Greece since 13 years. Previously he worked at the European Agency for Reconstruction (EAR) from July 2005 to end-2008. He was responsible for economic research and policy analysis, assisting in program coordination and the management of the Agency’s projects in the field of economic development and institution building in South Eastern Europe. Prior to his engagement with the EAR he was a Senior Investment Analyst for Southeastern Europe at the private sector financial institution Alpha Bank in Athens Greece between 1998 and mid-2005. Before moving to Greece he was DAAD lecturer in the Political Economy of Transition for Central and Eastern Europe at the London School of Economics in London, U.K. He holds a Ph.D. in Social and Political Science from the European University Institute in Florence, Italy. Jens is Managing Editor of the Journal of Southeast European and Black Sea Studies (Taylor & Francis, London). ELIAMEP’s mission is to provide a forum for public debate on issues of European integration and international relations and to conduct scientific research that contributes to a better informed and documented knowledge of the European and international environment

INTERVIEW by Jorge Nascimento Rodrigues, (c) 2010

Q: Greece was not in the worst situation regarding total external debt if we compare with Ireland (1050 percent of GDP) or even Great Britain (more than 400 pc of GDP), Portugal (220pc/GDP) or Spain (168pc/GDP). Why Greece surges as the critical point in the Eurozone regarding the risk of sovereign default?

A: The macro and microeconomic indicators for 2009 speak volumes. The budget deficit reached 12.7 percent of GDP. Registered unemployment was above nine percent, and youth unemployment surpassed 20 percent. GDP contracted 2 percent in 2009. Foreign Direct Investment declined 21 percent. Public sector debt corresponded to more than 114 percent of annual GDP. International credit rating agencies downgraded Greece’s sovereign credit rating and added a negative outlook. More than 10.000 shops closed during the past year. Tourism declined 13 percent and shipbuilding suffered heavily from the global economic crisis, declining 7.8%. In a word, the Greek economy is ‘dying a slow death’ as the credit rating agency Moody’s observed. The depth of the current crisis has revealed how paper-thin the image of the robust, growth-driven Greek economy was during the past decade. It is now becoming increasingly clear that Greece’s ‘economic miracle’ – as it was repeatedly termed by its political advocates – was based on a ballooning public deficit and a mentality of ‘buy now – pay later’.

Q: But what have the previous government of Kostas Karamanlis done with all that money?

A: Indeed many citizens and observers are now asking themselves, where has all the money gone. To illustrate, in 2006 public expenditure reached 42.9 percent of annual GDP. In 2009, only three years later, public expenditure had risen to 52 percent of annual GDP, while tax revenue remained at the same level as in 2006. In other words, the difference in expenditure levels relative to annual GDP corresponds to a 9.1 percent increase within three years! In absolute monetary terms this increase totals approximately €23 billion. This amount corresponds to the budget deficit in 2009 and constitutes roughly 45 percent of the government’s borrowing needs in 2010, which are said to be around €53 billion. Put otherwise, if public expenditure had remained at the level of 2006 today’s governing authorities would not have to confront the dire economic problems and budgetary challenges of 2010.

Q: The reaction from the new government leaded by the socialists was adequate?

A: Prime Minister George Papandreou addressed the nation on February 2^nd 2010 and announced a sweeping package of austerity measures that were adopted by Parliament in early March. These measures deserve credit for their courage. For once during the past six years a Greek prime minister delivered the bitter medicine without any attempt to sugarcoat the magnitude of the problem and the common effort required. It is essential for Papandreou that the economic and fiscal crises do not deteriorate into a wider political crisis the country cannot afford.  The effect of the proposed austerity measures is clear: there is absolutely no room for new domestic spending initiatives. The state’s coffers are empty. At a time of economic crisis, when deficit spending would be needed to stimulate growth, the Greek government has its hands tied behind the back. Moreover, the European Commission, the European Central Bank and the IMF are now looking over its shoulders.

Q: Would it be useful a European Monetary Fund (EMF)?

A: Whatever its usefulness, and whenever it may come into existence, it will already have been too late to assist Greece. Given that such EMF would need a change of treaty (Lisbon+Stability Pact) and a new definition of its relationship with the European Central Bank in Frankfurt, I do not see any appetite among EU members to proceed with such a proposal. Furthermore, the question of funding such an EMF has yet to be addressed. What currency unit would be used, according to what parameter of contribution by individual member countries?

Q: What kind of geopolitical consequences, if any, we can expect if the IMF comes officially to Athens?

A: The IMF is already in Athens since January 2010 providing technical expertise to the Greek government in areas such as budgetary planning, tax revenue capacity and statistical reporting requirements. In many ways, the austerity program that the Papandreou government has passed in March 2010 is a program that has all the ingredients of IMF requirements without having the title IMF, nor the resources from the IMF to support these measures.

Q: Do you think the Greek government has political capacity – like the Irish for instance – to implement those hard policies to curb the high public deficit until 2013 and to calm the debt markets?

A: Amid popular discontent and anxiety there appears to be one common thread of reasoning within Greek society, namely that the moral bankruptcy of the country has already arrived. The end of an era or the model of doing things Greek style has no future. Put bluntly, the Greece of yesteryear is bankrupt. What way forward then? And with whom, since many of the political and economic elites in the country are rather discredited? It’s a long shot, and it is going to be painful. Greek society is not yet prepared for nor convinced about the merits of this odyssey. Papandreou cannot be held responsible for the exorbitant fiscal deficit. But like it or not, the prime minister now owns this deficit. He must tailor its solution and cannot be seen as wavering on the deficit reduction objective. A multi-year program, not stop-gap measures, is the order of the day. Greece urgently needs to reform its nearly bankrupt pension system. At the same time, it requires comprehensive tax reform, including new sources of tax revenue and instruments to widen tax compliance among its citizens. Papandreou must show political acumen and leadership. This will require tenacity in the face of mounting social protests and entrenched special interests. Decisive and binding decisions to confront the challenges at hand are necessary. The government must establish new alliances, hold its ground and above all explain towards an unconvinced population why it is necessary to urgently change course.

Q: What do you expect from the European Council next Thursday (March 25) and Friday (March 26)?

A: In light of the degree of contradictory proposals and measures that have been advocated by different countries and institutions during the past weeks inside the EU, it would already be a success if the European Council could at least agree on a common agenda and deliver a joint communiqué at the end. Whatever the final outcome, the issue of helping Greece is not at the heart of the matter anymore. Rather, we are witnessing a situation where deep differences in substantial matters of EU policy coordination, what instruments to use and who should apply these are coming to the surface. The Greek crisis is only a symptom of a much larger and deeper crisis of the EU integration process, and its most important achievement to date, the common currency.

ECHOES FROM THE EUROPEAN COUNCIL

Jens Bastian opinion, from Athens (Updated March 26)

“Moreover, the introduction of more stringent means to avoid in the future similar fiscal and public debt crises opens a window of opportunity towards what will become known as European economic governance.”

“Establishing IMF assistance on the condition of Greece leaving the eurozone is absurd and can’t even be called an ‘analysis’.”

Q: How you evaluate the decisions from the European Council (March 25 and 26) regarding the Greek crisis?

A: The decisions communicated at the European Council meeting in Brussels are a mixed bag, with something to cheer about for everyone. First for Greece, because a combination of EU and IMF assistance has been put on the table, albeit with considerable strings and conditions attached to it. Furthermore, the rather unexpected statement by President Trichet of the European Central Bank to continue using Greek bonds as collateral will have immediate positive effects for international bond markets and Greece’s capacity to refinance itself when it again seeks to sell sovereign bonds, possibly already next week. Furthermore, the EU Commission can claim that the package keeps the Commission in the lead and underlines elements of European Solidarity. Moreover, the introduction of more stringent means to avoid in the future similar fiscal and public debt crises opens a window of opportunity towards what will become known as European economic governance. Finally, the German Chancellor A. Merkel can claim to her domestic audience that the decisions taken in Brussels do not put Germany anymore into the situation of being the ‘paymaster’ of the EU.

Q: Euroceptics forecast that IMF will “convince” Greece to pull out from the euro. This is a wishful thinking or a credible scenario?

A: That scenario is neither credible nor feasible. Establishing IMF assistance on the condition of Greece leaving the eurozone is absurd and can’t even be called an ‘analysis’. The IMF is already cooperating with the Greek authorities since January 2010 on grounds of providing ‘technical expertise’ in areas such as budgetary planning, tax administration and statistical transparency as well as public accounting. It now also has a mandate to provide financial assistance when requested. The Brussels meeting yesterday established a roadmap for such assistance if and when needed and requested by Greece.

“The lack of a federal government was one reason why many economists were sceptical about the Euro in the 1990s. At the time, they were ignored on the basis that the Euro is a political project. Very well: let the politicians lead that project to its logical conclusion.”

FAST INTERVIEW by Jorge Nascimento Rodrigues

Q: Do you think the Eurozone is suffering a severe speculative attack, particularly from hedge funds, as the EMU in the 1990s?

A: There is clearly speculation going on, and the speculators should be faced down. However, politicians should not use this as an excuse to avoid confronting the underlying causes of the crisis. There is a real problem in Greece, whose official statistics have been discredited. And there is a real problem in the eurozone, where the lack of a strong fiscal centre is leading to pressure on peripheral economies to deflate at the worst possible time. By contrast, in the United States the fact that the federal government spends a large chunk of US GDP means that net transfers are automatically made to regions in particular trouble, as a result of federal taxation and expenditure policies. The lack of a federal government was one reason why many economists were sceptical about the Euro in the 1990s. At the time, they were ignored on the basis that the Euro is a political project. Very well: let the politicians lead that project to its logical conclusion.

Q: The high fiscal deficits and sovereign debts are a real time bomb inside the Euro Zone?

A: Let’s focus on the real problem here. Unemployment is a time bomb in places like Spain. Excessive focus on deficits risks making this problem worse. If one little country like Ireland cuts expenditure right now, this will not make much difference. But if the entire periphery, including Spain and Italy, starts cutting then that is very dangerous.

Q: Do you think the best solution is the IMF intervention in the most risky country cases, or the European Union must take care of the problem, eventually with the observation model regarding Greece as a standard for the future and the launch of a Eurobonds initiative?

A: In a first best world I would favor a European solution, which would involve a bold step towards fiscal federalism. Thursday’s (Feb. 11, 2010, in Brussels) summit ought to send a strong message to markets that under no circumstances will any member state be left high and dry in the event of a market panic. If the market does panic, and Europe’s leaders do nothing, then of course the IMF should be brought in. If that happens, perhaps that will serve as a wake-up call to Europe’s vain and ineffective political elite.

PROFILE

Kevin O’Rourke is Professor of Economics at Trinity College Dublin, a co-organiser of the CEPR’s Economic History Initative and a Research Fellow of the National Bureau of Economic Research. He received his PhD from Harvard in 1989, and has taught at Columbia University, UCD, Harvard, and Sciences Po (Paris). He is currently serving as President of the European Historical Economics Society, and an Editorial Board member of World Politics. He contributes regularly to the Irish Economy blog and Vox.

Daniel Gros, director of the Center for European Policy Studies (CEPS) published end of last week a hot commentary in the Financial Times, which reappeared in the CEPS Commentary newsletter. The title speaks for itself: “Greek burdens ensure some Pigs won’t fly”. CEPS is a think tank based in Brussels.

The article sorted out in a very hot week for credit default swaps (CDS) spreads of Greece (jump to 404 basis points last Friday) and Portugal (historical pick Tuesday with 166 bp) and with huge speculation in Greek debt from hedge funds, which are betting that the country has a truly probability of default. Worse in West Europe only Iceland with more than 676 bp. The price of the CDS means that investors who want to insure €10 million worth of Greek government debt against default for five years have to pay more than €400,000 a year. Regarding the Portuguese situation, it would mean around €170,000 more. The equivalent hedging price for a German government bond amounts to just €36,000. A huge gap.

PIGS was the acronym for Portugal, Italy, Greece and Spain. But now, after the Great Recession and the sovereign debt crisis it was reengineered for Portugal, Ireland, Greece and Spain. The traditional Club Med got a member from the North Atlantic cold waters and expelled Berlusconi’s paradise.

In his article, Gros explained that the acronym is misleading. There are fundamental differences inside the new Debt Champions Club. Basically, Ireland and Spain has saving rates much closer to the Eurozone average. “This implies that Spain and Ireland will be able to finance government deficits from their national savings”. In the case of Greece and Portugal, it’s the reverse: “With such low gross savings it is not surprising to find that neither Greece nor Portugal have been able to finance even a minimum level of net investment from domestic sources”. “Greece and Portugal are unique in their reliance on foreign capital to such a large extent”, he wrote. The 2008 numbers speak clearly: excepting Iceland (with a gross national saving of minus 10.5% of nominal GDP), the two countries had the lowest percentages for gross national savings: 7.1% of GDP for the Greeks and 10.2% for the Portuguese. Ireland has 16.9% and Spain 20%.

Gros also refers that Greece and Portugal have been showing negative net national savings for several years. In the case of Portugal since 2004. The Portuguese situation in 2008 was even worse than the Greek one. In the case of Greece reached minus 5.5% of GDP, and concerning Portugal was minus 6.7% of GDP, a jump of 2 and 1/2 percentage points from 2007. After a decline in 2007, the net national Portuguese savings jumped from minus 6.7 billion euros to minus 11.3 billion in 2008.

Greece and Portugal are unique in the Eurozone in this topic. An unsustainable scenario for a majority of analysts. In the case of Portugal, Gros will suggest a radical therapy, a cut in consumption of about 10 per cent of GDP – €16.7 billion. He concludes in his article in FT: “Saving a country that is consuming too much makes sense only if the entire body politic accepts that more than fiscal adjustment is required. Deep cuts in private sector wages and consumption are needed before any outsider should even consider stepping forward.”

Daniel Gros came to Portugal this week for a private conference near Oporto.

INTERVIEW by Jorge Nascimento Rodrigues © 2010, janelanaweb.com

Q: A cut of 10 pc of GDP in public and private consumption means 16.7 billion Euros. Last year private consumption contraction was 0.9 pc but public consumption rose 2.6pc. For 2010, the budget projections refer a rise of 1 pc in the private and a cut of 0.9 pc in the public consumption. Very far away from your suggestion. You mean a one year cut or a program until 2013? A such a larger contraction would provoke a profound depression or not?

A: If a country -like Portugal- lives above its means for a long time, consumption has to be cut. If wage costs are cut at the same time exports can make up for the employment lost in the non tradables sector. This is what Germany did after 1995. It took a long time, but it worked.

Q: Large part of the population has no capacity at all for savings. Only in the middle class we have a certain degree for savings, namely private pension savings. But with growing unemployment in the middle class, savings and unemployment subsidies are vanishing. In the upper-class you assist to a run away for off-shores (more than 2.3 billion net added to the stock abroad between January and October 2009). How the 10pc of GDP cut would fuel savings and potential domestic pool of money available for investment?

A: I yet have to find a country where people would not say that it was absolutely impossible to increase savings because consumption is already too low. This is not true. In Portugal consumption has increased each year over the last decade more than production. This has to change. Investment in Portugal will increase again if wages are lower so that it becomes profitable to produce in Portugal for exports.

Q: Others are suggesting that those measures will be politically unfeasible and that would be more pragmatic to fuel inflation and contract the consumption real purchase power. What do you think?

A: An increase in prices in Portugal would be counterproductive because Portugal must export more. There is no way out other than a deep cut in nominal wages. If this is not done, Portugal will have another lost decade and be bankrupt even sooner.