Greece is officially back in recession after announcing its second consecutive quarter of negative growth; Q4’15 growth fell 0.6% qoq and growth for Q3 was revised down to -1.4% qoq from -0.9%. As the assessment of Greece’s compliance with the latest 2015 bailout package reforms takes place (to release further funds) this raises a number of issues.
The IMF, which is still to confirm whether it will join this third bailout, is pro-debt relief on the basis that Greece’s debt to GDP at ~175% is unsustainable; “assuming that Greece can simply grow out of its debt problem without debt relief—by rapidly transitioning from the lowest to the highest productivity growth within the eurozone—is not credible. Similarly, the very limited success in combating Greece’s notorious tax evasion—to make the well-off pay their fair share—means that pension reforms cannot be avoided by simply assuming higher tax collections in the future.” Both debt relief and pension reform will need to be undertaken.
Only once the government has implemented pension reforms, as agreed with its creditors, can debt relief be considered. Under the current system the creditors consider the Greek pension system is ‘unrealistically generous’ and ‘un-affordable’; budget transfers to the pension system are estimated to be ~10% of GDP. Obviously it is a highly contentious reform for Greek government to implement. Approaches to the problem differ with the Greek’s preferring to increase social security contributions to fund the payment and the creditors preferring cuts to the pension payments. But last week farmers, faced with higher social security contributions and taxes, held an acrimonious demonstration outside of parliament. This followed a massive general strike earlier in the month to protest against the austerity measures; estimates show the Greek economy has shrunk by ~25% since 2010. As Alexis Tsipras has stated “We must all understand that, next to balanced budgets, we must also have growth … We need to be more realistic, and show more solidarity too.”
The issue of growth versus budget austerity is not just a ‘Greek problem’ but remains a contentious issue particularly in Southern Europe where deflationary pressures are greater. Q4’15 GDP data showed Portugal growing only 0.2% qoq and it has had its own negotiations with the EU to get its budget which called for less austerity approved; but only after it conceded some further tax hikes. Italian GDP barely grew in the last quarter of 2015 registering growth of just 0.1% qoq. Matteo Renzi the Prime Minister has been open about the need for a more flexible approach towards budget austerity measures and commented "I am of the belief that austerity doesn't work on its own and can actually lead to the collapse of governments."
Elevated debt levels within the eurozone’s rules based framework, combined with reluctance to adopt a more expansionary fiscal stance by countries with the scope to do so (e.g. Germany), has constrained eurozone fiscal policy leaving monetary policy as the main policy lever. Structural reforms remain essential as a medium term driver of growth by boosting competitiveness and productivity. But with questions starting to be asked about the effectiveness of negative interest rates the magnitude of stringency applied to fiscal measures will increasingly be debated. Not surprisingly, the OECD issued a warning yesterday in its interim economic outlook in which it downgraded both global and Eurozone growth estimates for 2016 to 3% and 1.4% respectively stating; “The Outlook suggests that a stronger fiscal policy response, combined with renewed structural reforms, is needed to support growth and provide a more favourable environment for productivity-enhancing innovation and change, particularly in Europe.”
For us global growth looks to be weakening and the risks to be rising; this favours positioning in higher quality credits from ‘wealthy nations’ and bonds with a longer duration as the yield curve continues to flatten.