Monday, December 21, 2009

Weekly Hurriyet Column: Familiar Mediterranean Disease

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. For a change, I am giving up the usual cheesy movie reference in favor of a cheesy medical reference. As for the article itself, Gillian Tett reports that now banks are starting to worry about sovereign risk. As for Greece, its budget cut process has begun. And I argue in my piece, despite Greek claims their austerity measure is better than Ireland's, the latter seems to be doing a better job in swallowing the pills. Now that I have vindicated myself, on to the article:

The Greek fiscal tragedy next door entered a new phase last week when Prime Minister Papandreou announced the government’s austerity measures, which markets did not buy.

The PM’s speech, involving flashy phrases reeking of symbolism such as “the country must change or sink” or “we must embrace Spartan austerity”, was reminiscent of King Leonidas egging his 300 Spartans on to battle at Thermopylae. Equally encouraging was his admittance that the country’s woes go far beyond public finances.

Even if you dismiss his emphasis on corruption as an attempt to build consensus for unpopular reforms, competitiveness and higher education are two areas begging for reform. Compared to its counterpart across the Aegean, the Turkish Statistical Institute looks like a pillar of integrity, which has led Finance Minister Papaconstantinou to set up an independent statistics agency. Then, why did markets shrug off these gallant efforts and S&P downgrade Greece, following in Fitch’s footsteps?

For one thing, there is a tilt towards rosy estimates of revenue increases and new revenue streams rather than expenditure cuts in the government’s plan. As for the cuts, and most of the measures for that matter, there is worryingly little detail. And despite the PM’s assurances of pay freezes and decreases in allowances for civil servants, there is still talk of public-sector wage hikes in 2010. To add insult to injury, Greece seems to be suffering from lack of credibility.

But Greece is not alone. Italy, Spain and Portugal face a challenging year ahead as well. A case that has been off the markets’ radar for now has been Portugal. With the 2010 budget deliberations finalized in January and with a high rollover program for next year, it is conceivable that Portugal will be the second member of the PIGS to feel debt pains.

Another case of market ignorance, approaching delusion, is Turkey, with the latest budget figures declared positive by almost all the foreign outfits. With the sharp rise in yields earlier in the week having offered tempting buying opportunities, I would have claimed they were simply talking positions were I not such a good-mannered gentleman. While a couple of quick calls to bond traders did confirm large foreign names on the buy side, I’ll just wait for the official statistics.

To move from the trees to the forest, as Barclays Capital highlights in a recent note, the IMF, OECD and European Commission have identified that successful fiscal consolidation depends upon current expenditure cuts as opposed to revenue increases, including social spending, sometimes accompanied with a fiscal rule or multi-year target.

In practice, as BarCap notes, this implies that civil servant wage and social benefits cuts as well as pension reforms are key elements of successful fiscal adjustment. On the other hand, adjustments that would rely solely on duty hikes, indirect tax increases, fiscal fraud measures, or “savings” without any specification are unlikely to qualify as rigorous.

When you look at fiscal consolidation efforts through these lenses, it becomes clear that Latvia, Hungary and Romania are on the right path. And despite Papaconstantinou’s claim to the Financial Times that the Greek deficit reduction plan was more aggressive than Ireland’s, the latter surely wins more check based on the criteria above.

And this is also exactly where the 2010 Turkish budget gets it all wrong with its knockoff fiscal measures and over-optimistic revenue projections. Moody’s recently warned that 2010 could be the year of sovereign risk if developed countries could not get the timing of exit strategies right.

If that happens, Turkey could easily find itself at the PIGS’ tails.

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