COMMENCEMENT TIME

FOR THE GREEK ECONOMY

Gikas A. Hardouvelis
Professor, Department of Finance, Un. of Piraeus
Chief Economist & Director o Research, Eurobank EFG

September 24, 2010

Conference on Household Finance

Athens, Greece
 CONTENTS

I. Greece: The past & the future in concrete

numbers

II. Why does the market discount default with

high probability?

III. Can Greece get back to high & sustainable

equilibrium growth rates?

IV. Summary: Commencement time for Greece

Gikas A. Hardouvelis 2
 I. Real Growth Rates in Greece were higher
than in EU-15 from 1996 through 2009
7
%
4.5
5.9
4.5
Relative Living Standards
5
3.6 3.4 3.4
4.2 4.6 4.5 ΕΕ-15=100 in PPS
3
2.9 3.1 2.8 2.5 2.4 3.9 3.4
2.3
2.2 3.0 1991 76.5
3.0 3.0 2.6
1.8
1.2 2.0 2.1 1.7
2.7 1.9
1.2 1.8
2.0 2009 87.4
1
1.2
0.7 0,5
0.0 -0.3
-1

-1.6
-3 Source: EU -2.0

-4.2
-5
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
EU-15 Greece

Greece: From boom to bust

How come?
Answer: Not an equilibrium
growth

Gikas A. Hardouvelis 3
 I. Lack of competitiveness, which showed up in
current account and in inflation differential
Current Account Balance Inflation
0 5 %
4.2
-2 -2.8 Source: Bank of Greece 4 3.7 3.9 3.4 3.5 3.3
-4
-3.9 -5.6 -6.8
-5.8
2.9 3.0 3.0
-6 3
-7.3 2.1
-8 -6.5 3.3
-7.3
-7.8 2 2.2 2.2 2.1
2.2 2.4 2.3 2.1 2.2
-10 -11.3 -11.1
1.2
-12
1
-14 1.2
% GDP -14.4 -14.6 Source: European Commission 0.3
-16 0

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Greece Euro Area

Current Account (€ mil) -26,630.9
Goods 2009 -30,760.3
Services 12,640.2
Income -9,803.5
Current Transfers 1,292.6
Gikas A. Hardouvelis 4
 I. Almost always in fiscal trouble, but fiscal mess
grew prior to the onset of the 2009 recession
55% GDP Greece
Average Expenditures 1990 - 2007: 44.6% 50.5
50
46.4 46.6 44.7 46.8
45.7 45.3 48.4 48.4
44.8 44.9 44.4
45 43.7 44.7
44.1 44.6 44.1 44.3 43.0 45.0 45.5 42.9
41.3 40.3 39.7 39.0
40 40.5 41.7 40.5 40.9 38.0 39.1
39.2 39.0 39.0 39.7
36.3 37.4 38.5 36.9 38.5
35 36.7
31.8 34.5
33.2
28.9 9 Huge expansion in expenses already in 2008 EU
30 30.8 forecasts
28.4 9 In 2008, Greek real growth was 2%
25
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Revenues Expenditures

Gikas A. Hardouvelis Source: European Commission, Spring 2010 forecasts 5

 I. The Revised EU/IMF/ECB adjustment program

Assumptions
2009 2010 2011 2012 2013 2014 2015 2020
GDP Growth (%) -2.0 -4.0 -2.6 1.1 2.1 2.1 2.7 3.3
GDP deflator (%) 1.4 3.5 1.3 0.4 0.7 1.0 1.1 1.6
Nom. GDP (€ bn) 237 236 233 236 243 251 260 329
Int. Rate (%) 5.0 4.9 4.9 5.3 5.6 5.8 5.8 5.9
Bund Rate 225 275 350 350 350 350 350
Sensitivity analysis
Debt-to-GDP 2009 2010 2011 2012 2013 2014 2015 2020
Baseline 115 130 139 144 144 140 134 111
Higher growth
+1% per year 115 129 135 137 134 126 118 74
Lower growth
-1% per year 115 132 144 151 155 154 152 154
Source: Revised EU/IMF/ECB adjustment programme

9 In the optimistic scenario, debt/GDP will be in 2020 where Spain is today

Gikas A. Hardouvelis 6
 Ι. The Revised EU/IMF/ECB program: Detailed forecasts

2009 2010 2011 2012 2013 2014 2015 2020

Current Account
(%GDP) -11.2 -10.8 -7.8 -6.9 -6.0 -5.1 -4.0 ---
Gen Gov Deficit
(%GDP) -13.6 -7.9 -7.3 -6.2 -4.7 -2.5 -2.0 ---
(€ bn) -32.3 -18.6 -17.0 -14.7 -11.5 -6.2 -5.1 ---
Gen Gov Debt
(%GDP) 115.2 130.3 139.4 143.6 144.0 139.5 134.0 111
(€ bn) 273.5 307.5 324.6 339.4 350.0 349.5 348.7 365.1
Interest Expense
(%GDP) 5.0 5.6 6.5 7.2 7.8 8.1 7.8 ---
(€ bn) 11.9 13.3 15.2 17.1 18.9 20.4 20.3 ---
Primary Surplus
(%GDP) -8.6 -2.2 -0.8 1.0 3.0 5.7 5.9 6.0
(€ bn) -20.4 -5.3 -1.8 2.4 7.4 14.2 15.2 19.7
Source: EU/IMF/ECB adjustment programme

Gikas A. Hardouvelis 7
 II. Material risks exist but can be contained

a) Will the recession end soon? As European belt-tightening is currently taking place,
low European growth may cause Greek economic growth to stall. EU funds are not
sufficiently mobilized yet, while privatizations have taken the back seat. Drastic
initiatives on growth required.
Yet, Greece is a relatively closed economy and over half of its exports are
channeled outside the Euro Area. In addition, core EU still growing. Once
sentiment stabilizes, private investment may stop declining, giving a boost to
domestic output
b) Risks of the Gargantuan task of grabbing tax evasion without instituting moral
hazard through frequent tax amnesties
Yet, a switch to a stable and transparent tax regime requires time to implement
and in the meantime revenue collection expected to suffer
c) Risk of silent anger from the population of wage earners in H1 2011 with the rise in
unemployment and decline in incomes and if government fails to address the
rampant tax evasion
d) High bond risk premia may persist, which could prohibit Greece from tapping the
bond market in two years or so
Yet, if program is successful Ö risk premia ought to decline, while a lengthening
of the maturity of the EMU €110 bn loan is likely
e) Collapse of the financial system: Is it probable?
No, as long as ECB provides liquidity and no population panic takes place.
Gikas A. Hardouvelis 8
 II. The market is extremely negative and
oblivious to the change in risk sources
A nervous market 1100
bp 5-year CDS rates
1000
9 On September 17th,
5-yr CDS 900
Greece & Ireland
was 885.5 bps implying 800
700
™ a cumulative risk-neutral 600
probability of 34.3% for a 500 Source: Bloomberg
total capital loss any time 400
during the 5-year period, 300
200
™ or a 99.9% probability for
100
a capital loss of 10%

2/11/2009
13/11/2009
24/11/2009
5/12/2009
16/12/2009
27/12/2009
7/1/2010
18/1/2010
29/1/2010
9/2/2010
20/2/2010
3/3/2010
14/3/2010
25/3/2010
5/4/2010
16/4/2010
27/4/2010
8/5/2010
19/5/2010
30/5/2010
10/6/2010
21/6/2010
2/7/2010
13/7/2010
24/7/2010
4/8/2010
15/8/2010
26/8/2010
6/9/2010
17/9/2010
9 Even more worrisome is the
following: On September 21st
the 2-year Greek Government
Greece Ireland
bond yield was 9.3%, a spread
of 851 bps over Bunds!!
9 Yet Greece does not need to go the market to get financed for 2.5 years! Illiquidity?
Overreaction? The market seems to believe that:
™ Either the Greeks are incapable of absorbing the €110 bn rescue funds
™ Or the EMU members will not be able to deliver the funds

Gikas A. Hardouvelis 9
 II. Once primary balance is attained
it makes no sense to default
Markets appear oblivious to this regularity
9 Cottarelli et.al:
Countries are forced
to default, they do not
choose it
9 Once advanced Cottarelli et.al.
countries bring (2010), IMF
primary deficit to zero,
they continue fiscal
tightening
9 After sovereign bond
spreads rose above
1000, no credit event
in 80% of cases
9 In the case of Greece,
default would not
solve its fiscal
problem

Gikas A. Hardouvelis 10
 II. Yet, should Greece default
if program were to succeed?
The argument goes that if the EU/IMF/ECB Program succeeds and in 2012-2013 Greece
begins generating the first primary surpluses, then it would be tempted to restructure
its huge debt. However, this event cannot happen because:
1. A Greek default would be an EMU decision, not a Greek decision. Stakeholders
of GGBs are primarily Greeks and other EMU members. They do not want a default.
i. Greek banks own approximately €45 bn, pension and other funds another
€25bn, individuals around €15bn. Thus, a haircut would force the
government to bail out its banking sector and its pension system
ii. EMU banks hold a major chunk of GGBs, most of it posted at the ECB as
collateral. EMU members would object to a default. It may create FI
bankruptcies in EA-16.
iii. The ECB holds significant amounts of GGBs both directly (~ €23 bn) and in
the form of collateral. Greece cannot go against its own lender of last resort
iv. EMU countries have given €80 bn in loans (& IMF €30 bn), on which Greece
cannot default
2. Risks of contagion in the European financial sector with a possible spread of fear
for EMU sustainability
3. Huge adjustment costs for Greek borrowing during the default/restructuring process
and inability to tap the markets for a long time
4. Interest costs will increase for the Greek private sector as well, reducing growth
Gikas A. Hardouvelis 11
 III. Can Greece resume its past high growth rates?

1) Reforms are drastic & on time, particularly the pension, labor

and fiscal ones - Strong inertia for reforms - Government
ahead of the curve
2) Unusually benevolent political environment
3) An end of the recession by sometime in H2 2011 is within
reach, yet more drastic action is needed
4) In the intermediate-run, growth can come back - making the
level of debt less onerous
i. A strong private sector, which is under-levered with rich
citizens, plus a conservative banking sector
ii. There is a strong growth potential in Greece,
especially if competitiveness is restored

Gikas A. Hardouvelis 12
 30%
80%
130%
180%
230%
280%
330%
380%
% of 2010 1GDP
E A -1 6 20
,3
34
L u x /b u rg 5,

Gikas A. Hardouvelis
29 7
C y p ru s 2,
21 9
D e n m a rk 8,
20 1
Ire la n d 5,
17 1
S p a in 8,
17 9
P o rtu g a l 0,
16 2
N e th e rla n d s 8,
16 2
M a lta 3,
13 8
S weden 5,
11 7
A u s tria 7,
10 0
L a tv ia 8,
10 4
Ita ly 7,
10 5
G re e c e 6,
10 3
E s to n ia 5,
9 Private leverage low

10 1
G e rm a n y 4,

June 2010, % of 2010 GDP (EU forecasts)

10 0
F ra n c e 1,
8
92
S lo v e n ia ,4
92
F in la n d ,0
86
B e lg iu m ,3
75
B u lg a ria ,7
68
9 Greek bank deposits are 1.1 times GDP

L ith u a n ia
Private Loans / GDP

,6
III. Greek private sector is rich and under-levered

63
H u n g a ry ,6
51
C ze c h
Loans to non MFIs excl. Gen. Government from MFIs excl. Eurosystem,

,1
46
P o la n d ,9
46
9 Greeks own a large fraction of international shipping

S lo v a k ia ,4
38
R o m a n ia ,4
13
 III. A solid banking sector:
Greek banks prudent and strongly capitalized
9 Greek banks did not cause the recession in
1.6
Return On Assets
the country like it occurred in the US or in EU-27
1.4
Western Europe
1.2 Greece
9 The banking system is deposit rich (L/D 1.0
118% for banking groups); ECB offers strong 0.8
support, while contingent liquidity (now over 0.6
20% of deposits) will be further boosted 0.4
(covered bonds, government’s liquidity 0.2
scheme, limited refinancing needs) 0.0
Source: ECB, BoG
-0.2
9 Greek banks strongly capitalized (CAD ratio
at 11.7%, Tier I at 11.0%) 2007 2008

9 Asset quality worries seem overblown (NPLs at 8.2% in 2010-Q1, experience of two
crisis years, NE countries); Greek private sector is not over-leveraged; Pre-provision
margins 40% wider than EU; absence of toxic assets and no real estate bubble
9 Substantial CEE/SEE exposure offsets Greek strain; profits to track economic
recovery in the region
9 Greek banks have annual net revenue buffers in excess of € 3.5bn, including: 2010
profitability run-rate, further re-pricing in Greek loan segments, streamlining of
operations and cost containment as well as synergies from potential sector
consolidation
Gikas A. Hardouvelis 14
 III. Strong growth can resume in the future
High productivity growth can continue in Capital Intensity
the future, once the recession is over, for a
number of reasons:
9 Capital intensity lower than EU average,
infrastructure projects needed, funding is
available
9 Real wages are declining by over 10%,
improving competitiveness, which did not
deteriorate a lot in the serves sector
200
9 Public sector crowding in, Structural Growth in Unit
Labor Costs
reforms & building of social institutions 180
relative to trading
will result in a more export-oriented and 160 partners
competitive economy, with gains
estimated by some researchers at 140

around 20% of GDP

120

9 Capturing the underground economy,

100
which is close to 25-30% of GDP, will
improve all debt magnitudes. 80
2000 2001 2002 2003 2004 2005 2006 2007 2008
EUROSTAT revisions expected soon.
Gikas A. Hardouvelis
Industry Agriculture Services 15
 IV. Summary: Commencement time for Greece

9 Despite significant risks, the EU/IMF/ECB Program has a high chance to succeed as
fiscal consolidation proceeds as planned, drastic structural reforms are ahead of the
EU/IMF/ECB conditionality dates, the public is not responding negatively to belt-
tightening and the governing center-left political party has strong parliamentary majority
and can stay in office for additional 3 full years.
9 Markets presently discount a significant haircut in Greek government bonds. Yet,
once primary surpluses become feasible in 2012-13, debt restructuring would not be
optimal as the stakeholders are Greek or other EMU members.
9 The recession is expected to be over by 2011 H2, once investment spending stabilizes
and the net export sector improves its share in domestic value added.
9 Long-term growth can gradually recover:
ƒ From expected further productivity gains coming through faster capital
accumulation, lower real wages, public sector crowding in, product market reforms
plus a gradual capturing of the underground economy
ƒ The strength of the under-levered and wealthy private sector and the strength of
the banking sector
9 The current account imbalance and competitiveness can improve thanks to on going
product and labor market reforms and the re-organization of the public sector
9 This is commencement time for the Greek economy, to be built on consensus

Gikas A. Hardouvelis 16
 THANK YOU FOR YOUR ATTENTION !

[email protected]
+30-210-333-7365
www,hardouvelis.gr

Gikas A. Hardouvelis 17