Greek Aid Terms May Be ‘Red Herring’ Amid Recession (Update1)

By Jonathan Stearns Bloomberg
April 12 (Bloomberg) — Greece’s rescue package from the European Union will do little to bolster economic growth even as it staves off the immediate risk of default, said economists at Goldman Sachs Group Inc., HSBC Holdings Plc and Morgan Stanley.
Euro-region finance ministers yesterday offered Greece as much as 30 billion euros ($41 billion) in loans at a rate of around 5 percent as the government cuts wages and spending to tackle the EU’s largest budget deficit. Another 15 billion euros in aid would come from the International Monetary Fund.
“The real issue will be whether Greece can regenerate growth while cutting the fiscal deficit,” Erik Nielsen, London- based chief European economist at Goldman, said in an e-mailed note. “Without growth, the debt is only sustainable if someone will finance them at much less than 5 percent” for at least the next decade. “The exact interest rate charged on the bailout package is a bit of a red herring.”
The Greek economy, which contracted 2 percent in 2009, risks being dragged down by government austerity measures that have already sparked a wave of protests in Athens. Even after this year’s measures, which also include tax increases, Greece will have a budget gap of 8.7 percent of gross domestic product.
The economy could contract as much as 4 percent this year, the most in more than three decades, Deutsche Bank AG estimates. Yesterday’s EU aid offer was meant as a reward for the austerity efforts and as a tool to enable Greece to keep selling bonds on the market after Greek borrowing costs surged to an 11-year high least week.
Massive Fix
“It may certainly reduce the possibility of default on a near-term basis,” said Morgan Stanley Asia Ltd. Chairman Stephen Roach in an interview on Bloomberg Radio today. “But you have to ask yourself: how the heck is Greece going to do the massive fiscal adjustment they have supposedly agreed to in a short period of time when they get these funds?”
Greece last week raised its estimate of the 2009 deficit from 12.7 percent of GDP to 12.9 percent, the highest in the euro’s history and more than four times the EU’s 3 percent ceiling. While rules foresee fines for nations that exceed the limit, no penalty has ever been imposed.
Greece’s goal of reducing the deficit by four percentage points this year is part of a plan to bring the budget gap within the EU limit by the end of 2012.
‘Much Tougher’
“Lowering the deficit towards 3 percent of GDP in the subsequent three years will be much tougher and the markets will require much more convincing along the way,” said Janet Henry, chief European economist at HSBC in London, in a research note.
Greek bonds jumped today in response to the rescue package, pushing down the two-year yield to 5.807 percent from 7.158 percent on April 9. The 10-year yield dropped 55 basis points to 6.66 percent.
The EU-IMF aid offer of as much as 45 billion euros is for 2010. The package, unprecedented in the 11-year history of European economic and monetary union, covers three years and leaves open the sums of possible aid in 2011 and 2012. Greek, EU and IMF officials were due to meet today to start working on details.
Some economists said that the Greek rescue plan may encourage others to slow deficit-cutting plans. Paul Mortimer- Lee, head of market economics at BNP Paribas in London, said Europe was engaged in a “game of fiscal chicken” over Greece.
‘Tough Choices’
“It was the eurogroup who swerved to avoid the crash,” he said in an e-mailed note today. “The Greek decision has introduced, or increased, the incentive for governments to avoid tough choices and to let their finances drift or not to try hard enough to consolidate.”
Mortimer-Lee pointed to the implications of the agreement for Portugal, which wants to cut its deficit from 9.3 percent of GDP last year to 2.8 percent in 2013.
The EU should consider putting in place a “pre-emptive” aid package for Portugal, Simon Johnson, a former IMF chief economist, said in a Bloomberg Television interview today.
For Johnson, who is now a professor of finance at MIT Sloan School of Management, the plan increases the risk of “moral hazard” in Europe.
“This is not fixing the issue,” he said. “The Greeks could seize the opportunity. You have taken away their incentive to solve the problem.”
Greece will probably have to tap the loan package to meet debt payments in May, said Goldman’s Nielsen and HSBC’s Henry.
Greece needs to raise 11.6 billion euros by the end of May to cover maturing bonds. A total of 8.5 billion euros of Greek 10-year bonds matures on May 19.
“The impending redemption hump on May 19 makes it extremely likely that Greece will also have to draw on EMU-IMF loans,” Henry said. Nielsen said: “We continue to think that such official money will indeed be needed to get them through May.”
To contact the reporter on this story: Jonathan Stearns in Brussels at [email protected]