Last Sunday, French and Greek citizens went to the polls to elect new governments. In France the result is clear with Socialist Party candidate François Hollande garnering just under 52 per cent of the vote; in Greece it is less apparent. The French result is in line with both market expectations and exit polls; drops in European bourses on Monday morning relate more to the Greek stalemate rather than the French result.
We see a great risk that the austerity programme in Greece will not work- Vincent Micallef
At face value, Mr Hollande’s pre-election promises of replacing austerity with growth measures might be harmful to the country’s growth prospects. One macroeconomic theory suggests that government spending is the ideal tonic in times of recession. But as the FT pointed out in an article last week “…if building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming”, citing the marvels of Athens’ metro and Spanish AVE fast trains.
Other European countries have had to take unpopular decisions mainly to ensure that they can continue tapping the debt markets at sustainable levels, generally believed to be in the seven per cent area. Both Spain and Italy flirted with these levels in November last year but have since managed to pull their 10-year government bond yields to around 5.70 per cent and 5.35 per cent respectively.
It is understandable to assume that politicians want to balance what is good for their country and what will bring (or return) them to power – which is why technocrats were deemed to be the best solution in the current euro scenario. Take Gerhard Schroeder however, widely considered as the engineer of today’s robust German economic muscle. After his SPD party was delivered to power in 1998, Mr Schroeder embarked on policies designed to restore German competitiveness hampered by the burdens of German unification and subsequent above-average increases in labour costs. The end result was a nationwide lowering of wages and industrial costs – unpopular policies which ultimately caused his defeat to Angela Merkel’s CDU in 2005.
The incumbent coalition parties in Greece, New Democracy and PASOK, only managed to collect a third of the vote. On Monday, New Democracy – the party with most votes – was given the mandate to form a coalition, but within the day handed it back to the President after abandoning attempts to find common ground with other parties. SYRIZA and PASOK (second and third in Sunday’s vote) respectively will now be asked to form a government, but the risk is that new elections will be necessary – possibly in mid-June. Any new government would then need to secure parliamentary approval for cutbacks agreed with the troika by the end of June, amounting to €11.5 billion.
We believe that the austerity measures meted onto Greece by the troika were far too aggressive. Granted that the country went through a long period of irresponsible fiscal policies, but the measures forced upon the country were overly front-loaded. It is almost inevitable that Greece will fall into a vicious cycle: recession caused by austerity over such a short period will lead to new fiscal shortfalls; the natural reaction would be to raise more taxes which in turn will push the country into further recession.
According to the IMF, Greece tightened its primary deficit by 11.5 per cent of GDP in just two years, and the economy is shrinking by circa seven per cent per annum.
The austerity measures were not blended with pro-growth efforts enacted by countries such as Spain. The latter put into place programmes such as labour market reforms and tax incentives to tackle high levels of unemployment. Greece needs measures to attract activity and investment, but austerity on its own has the effect of repelling it.
All in all we see a great risk that the austerity programme in Greece will not work – perhaps forcing the country out of the euro. This might not come as a major surprise to the market. However it could have a major effect on the European banking system, especially in the euro peripheries, should there be a forced conversion of Greek euro deposits into drachmas. In this case, the European Central Bank would have to act early to avoid contagion and combat capital flight away from other weaker euro countries.
This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Some of the opinions expressed here are of a forward- looking nature and should not be interpreted as investment advice, nor should it be considered as an offer to sell or buy or subscribe to any investment vehicles or strategies that might have been mentioned in the article.
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Mr Micallef is an executive director at Curmi and Partners Ltd.