Fiscal finances the world over are feeling the deep effects of recession. Support for the ailing world economy was swift, substantial and synchronized in late 2008, creating large deficits that are now being widened as unemployment and lower business activity erode revenues. Hints of downgrades to AAA-rated countries, let alone the multitude of lesser credits, are a hot news item. In this context, it is no surprise that Greece is the latest draw for the economic paparazzi.
Public debt levels in Greece have long been close to the top of the OECD charts. But markets were still shocked last October when Greece revealed a much larger 2008 budget deficit than previously reported, and a 2009 shortfall estimated at 12.7% of GDP. OECD figures already had Greece’s debt-to-GDP ratio deteriorating from 103% in 2008 to 130% in 2011 before the revision; instantly, a bad situation was worse. The shock was ill-timed: it coincided with the Dubai World default, and the ECBs announcement of the withdrawal timetable for extraordinary liquidity measures. In response, CDS spreads jumped from 125 to 300 basis points (bp) by year-end, and are currently hovering at 400bp.
Mounting external concern prompted calls for an internal solution. Markets hoped for an Irish-style plan, but the January announcement was too vague, prompting the European Commission to impose closer surveillance on Greece than ever before seen in the EU. That action gave rise to a detailed austerity plan on February 2 that for the moment has placated markets. But implementation of the wage freeze, labour and pension reforms, and fuel taxes may prove a difficult sell to voters.
Fears were allayed somewhat in recent weeks, as the government’s 5-year €8 billion bond was three times oversubscribed – good news, given that the government will soon tap the market to finance an additional €25 billion. However the premium over German bunds was steep, at 360bp. With a total of €54 billion borrowing requirements this year, the debt servicing burden with such a high risk-premium will be an onerous, and more permanent, addition to an already-strained budget.
The fiscal shock extends beyond Greece. The world economy remains precarious, and bad news has a broad effect on confidence. In addition, this duress is occurring inside the OECD and the Eurozone, not in emerging markets – much closer to home than normal. It follows that the shock is rippling through the region’s financial system while it is still benefiting from emergency measures and closing in on the peak of the default cycle – a particularly vulnerable moment for banks. Moreover, Greece’s access to emergency funding is at risk; with a sovereign rating as low as BBB+, Greek government bonds will no longer meet the ECBs threshold rating requirement for collateral by the end of 2010.
A further effect of Greece’s woes is increased scrutiny. No sooner was last week’s plan in place than markets shifted their focus to Portugal. Revelation of a larger-than-expected budget deficit in 2009 at 9.3% of GDP sent bond spreads up to 242bp, and knocked 3% off the stock market index. Spain was also mentioned on the airwaves, and renewed jitters will likely keep markets on heightened alert.
The bottom line? The severity of the recession is showing up in nasty fiscal surprises, which are jolting markets at a vulnerable moment. Fiscal austerity plans will assuage financial markets, but the hope is that recovery in the rest of the economy kicks in ahead of the withdrawal of public funding.