THE Greek government has committed to reduce the fiscal deficit to 8.7 per cent of GDP by 2010, a reduction of ¤4.8 billion, through a series of measures both on the revenue and expenditure side. Revenue measures include increases in the Value Added Tax (VAT) and excise duty rates. On the expenditure side there will be cuts to the wage bill, cuts in public investment and current spending. The problem, however, is that some members of the population (labour unions) seem to be against the fiscal austerity measures (violent strikes, mass demonstrations), which makes the task more difficult.

The lack of public support for the measures puts a further negative light on the pace and possible effectiveness of the policies and paints a negative picture in the international markets. The markets may draw the opinion that citizens of Greece do not know the extent of their fiscal issues or they may know but are more interested in individual gain rather than the country as a whole. Whatever their reason, it tells the market that policies will be difficult and time-consuming to implement; thus a quick turnaround is not likely, and exposure (investment) to Greece, therefore, risky. In Jamaica, while some labour groups have expressed their displeasure at the austerity measures, in general there is consensus among the wider populous.

Standard & Poor’s acted on April 27th to lower Greece’s ratings from BBB+ (investment grade) to BB+ with a negative outlook (increasing the likelihood of further downgrades). The rating agency also attached a recovery rating of “4” to the country’s bonds, indicating an expectation of average (30% to 50%) recovery for debt holders in the event of a default. Again it seems clear that a debt restructuring may be imminent. The agency believes that the ‘crisis of confidence has raised uncertainties about the government’s capacity to implement reforms quickly and its political resolve to embrace a fiscal austerity programme of many years’ duration.’

The market has also tied Greece’s fortunes to the rest of the Eurozone and is demanding an explanation of how Europe intends to raise its current growth rate to more acceptable levels. Real GDP growth in the Eurozone averaged 2.25 per cent from 1981 to 1993 but slipped to 2.0 per cent between 1993 and 2003 and now stands at approximately 1 per cent. The market is concerned that the Eurozone, growing at 1%, will not be able to create new jobs and sustain social systems.

Growth in Greece is driven by two main sectors, transport services and tourism, which are vulnerable to shifts in global income levels. Tourism alone contributes 15 per cent of GDP while the public sector accounts for about 40% of GDP. The large contribution of the public sector to GDP — plus the fact that nominal wage growth regularly exceeds productivity — is a clear indication that the size of the public sector is a burden on the fiscal numbers. Interest payments as a percentage of revenues average approximately 12 per cent, thus to consistently run a primary and fiscal deficit means that wages and other expenditure items represent in excess of 88 per cent of revenues.

But there are further problems! The market does not trust the statistics provided by the Greek authorities because of their history of inaccurate and misreported data. Plus there is a large informal economy and tax evasion seems commonplace in the society. According to OECD estimates, the informal economy in Greece represents between 25-30 per cent of GDP.

Synopsis

The above factors indicate that while a substantial bailout package has been put forward, the market has reason to be concerned about Greece and the Eurozone. The bailout package itself may also be a concern; if the countries in the Eurozone are already in trouble raising/ guaranteeing additional debt, even if the lion share is from the more affluent nations, this still increases the risk of investing and the fiscal burden.

Also, some members of the union, eg Germany, are facing pressures from their citizens to address domestic problems rather than look to aid a country that has been fiscally irresponsible. Thus, the market has a right to be concerned.

Implications For Jamaica

The recent turmoil in the global financial markets may actually have both positive and negative implications for Jamaica. The recent devaluation of the euro will have positive implications since 17.18% of Jamaica’s total external debt, of US$6.59 billion, is actually euro-denominated. The recent appreciation of the J$ vs $US is also a major positive for the country’s debt dynamics. Year to date, the dollar has actually appreciated by 0.94% (87 cents). Based on available data, a $1.00 appreciation of the currency leads to J$6.37 billion in savings, thus an 87-cent appreciation leads to approximately J$5.53 billion in savings.

On the negative side, the turmoil in Europe could mean another global recession (double dip), especially if Greece defaults. A default could lead to contagion, causing the market to question the fiscal soundness of Spain, Portugal, Ireland or the entire European Union. If the default terms are not market-friendly this could also lead to another credit crunch if banks refuse to lend to each other because of fears regarding the presence of Greek debt on balance sheets. This would effectively prolong the global downturn. The devaluation of the euro also means that the US-visitor/tourist will find it cheaper to travel and shop in Europe. This may have negative implications for Jamaica’s tourism product, especially when accompanied by an appreciation of the J$ is the US$. However, the majority of visitors to Jamaica are from the low-to-middle income range while travellers to Europe tend to be high-end travellers; hence the impact may be minimal if at all.

Investment Strategy

It is clear that the Eurozone still has issues to address. The markets seem to be convinced that a default is a strong possibility and recovery for debt holders after default is deemed average (S&P). Shorting the euro may seem like the obvious strategy but the possibility exists that the market may have overacted/oversold the euro and a correction is imminent. Thus, a long position in euro vs USD is another strategy worth exploring. Buying CDS (Credit Default Swaps) on Greece is another strategy but a Greek default may have been fully priced in already, consequently CDS exposure may be expensive.

The strategy we like the most is buying EM sovereign bonds that may have been excessively beaten up. Whenever there is a hint of a global crisis, investors tend to dump emerging market (EM) global bonds wholesale, ie incorrectly looking at EM assets as a single class and dumping even high-quality assets with strong fundamentals. Many EM sovereigns have commodities stabilisation funds that allow them to run counter-cyclical fiscal policies (Chile-copper, Russia-oil etc). We suggest research and possibly buying (on a pull back) assets such as Brazil (2027’s, & 40’s), Colombia (2020’s), Peru, Mexico etc that are fundamentally strong and well diversified.

For those investors who were burnt by the recent global recession or do not have the appetite to play in the high-risk environment, it may not be a bad strategy to simply “stay at home”. That is, simply purchase what you know: good old GOJ. The recent political volatility and fall off in prices may represent a buying opportunity. The country still has many positives going for it, including — the passing of the IMF test, currency stability (in fact currency appreciation), low domestic interest rates since the JDX and the possibility of lower rates going forward, reasonable deficit targets and general economic stability. In our opinion the political risk will pass, there may even be significant positive implications if the security forces put a serious dent in crime. Consequently, GOJ globals are as safe a bet as any at this time.