Will Greece Bail on Its Bailout Terms?

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Will Greece Bail on Its Bailout Terms?

By Martin Hutchinson, Global Markets Analyst

The Greek leftist Syriza party had a convincing win in September’s elections. Now, its leader Alexis Tsipras must start implementing the European Union (EU)-imposed austerity program.

By appointing a pro-bailout cabinet, Tsipras showed that he intends to at least attempt to comply with the bailout’s conditions. Tsipras has retained the team that negotiated the latest bailout, including finance minister Euclid Tsakalotos, after the previous anti-bailout finance minister Yanis Varoufakis was fired in July.

However, the bailout terms remain thoroughly unpopular in Greece, as evidenced by July’s referendum.

While Greece’s compliance with the bailout terms is by no means assured, it’s doubtful whether the EU has the courage to do anything but give Greece the money.

The bailout includes provisions such as reforming state pensions, tax increases on farmers, privatization of state banks, and liberalization of closed markets. All of these are bitterly opposed by one element or another of Tsipras’ leftist/nationalist coalition government.

But there are some things this government can agree on. Particularly imposing a more realistic level of tax on Greece’s ultra-rich and low-taxed shipping companies.

Not Such a Heavy Debt

As the EU demonstrated during negotiations earlier this year, they’re very unwilling to force a default on Greece’s debt or take away the euro common currency. Thus, it’s likely that the EU will tolerate a considerable amount of foot-dragging and prevarication.

Much of Greece’s 86 billion euros ($97 billion) of bailout funding will probably be released in dribs and drabs, just in time to make the repayments due on Greece’s outstanding debt and recapitalize its staggering banks.

Greece has too much debt – a total of about $360 billion – that’s clear. However, about $290 billion of that is owed to the IMF and the EU on low-interest, long-maturity terms, with about $220 billion of that produced by the first two bailouts. Hence, the downside of a Greek default on markets wouldn’t be huge.

Conversely, the downside of a default from the EU and IMF would have serious consequences. And the effect of extending terms on Greek debt and rolling it over isn’t that great, either. The most important thing is that enough money flows into Greece to balance the country’s year-by-year cash flow, allowing it to employ most of its people and preventing it from spiraling downward into economic death.

Keeping Up With the Joneses

There are signs that Greece is quite close to a sustainable position. Greece’s GDP per capita (a rough comparative measure of wage levels) was $32,000 in 2008. That’s far above any level that could be sustained by the market.

When you consider that neighboring Bulgaria’s GDP per capita is $7,500, Romania’s is $9,500, and Turkey’s is $11,000, you can see that any GDP per capita level above about $15,000 for Greece is likely to make the country uncompetitive. That gap seems impossible to close through austerity.

When the Greek crisis first broke, I was in favor of Greece leaving the euro as it would’ve closed the gap through the “new drachma” falling to about half its previous level. But Greece’s per capita GDP dropped to $22,000 in 2014 and will have fallen even further this year. With political will from the new Greek government and lavish subsidies from the EU, the remaining gap ought to be easily closed.

The Greek GDP grew at an annual rate of 0.8% in the second quarter of 2015, a surprisingly strong showing. This suggests that with further economic reforms and moderate austerity, the country may be approaching equilibrium, at which point new jobs could be created.

There’s also the possibility of subsidies in one form or another from the EU.

With the Greek GDP at only $240 billion, a 10% annual subsidy from the EU, totaling $24 billion in economic value and disguised in whatever way seems most attractive, seems perfectly feasible. That would subsidize Greek wages (about 60% of GDP) by 15% to 16% and make them internationally competitive.

When There’s No “Right,” Choose “Best”

Greece has an incentive to stay in the euro while grudgingly instituting some of the EU’s reforms. The EU has an incentive to keep rolling over Greek debt and passing out subsidies large enough to balance Greece’s books and keep its people employed.

Another subsidy isn’t what anyone would consider an economically optimal solution, but it is politically optimal, and that’s what counts.

For investors, Greece remains a place to avoid, and so do Greek shipping companies, which may be subjected to additional taxes.

On the other hand, the inefficiencies of the EU are already priced in by the market, so if you don’t have any money there, you probably should have a little.

The iShares Europe ETF (IEV) is a substantial operation that includes shares of Sweden and the United Kingdom. It aims to match the S&P Europe 350 Index (which doesn’t include any Greek companies.) IEV has a P/E of a reasonable 15 times, annual expenses of 0.60%, and a decent dividend yield of 2.8%.

Good investing,

Martin Hutchinson

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By Martin Hutchinson