Rob Kyprianou: Exploding the myths behind the Greek crisis

Rob Kyprianou is one of Britain's foremost economic and investment experts. He is currently on a walking challenge to raise money towards a cure for MS. More details here: http://1000miles4hope.com.

You cannot get away from it – headlines about Greece’s budget problems are everywhere; pundits come forth to tell us it is serious for the Euro and that the whole European project is at risk, yet investment bankers are on the road selling Greek government bonds at spreads of 3 to 4% over their German equivalents telling us how the EU will not let it happen and that the Greeks are taking corrective action.  Crisis summits with EU leaders are convened where senior officials and Heads of State are rolled out to say that the EU is a family and they will take care of their own, while behind the scenes giving Greece ultimatums and deadlines and no detail on how any aid may be forthcoming.

What is the reality behind all this superheated noise and does it really matter to investors?

First let’s explode some myths.

Myth Number 1 – the Greek budget deficit is no worse than some other major countries, so why all the fuss? 

The budget deficit this year will be around 12-13% of GDP, similar to the UK, and only a little ahead of Spain and Ireland (10-11%). Total outstanding government debt is around 112% as a per cent of GDP, comparable to Italy, way below that of Japan approaching 200%, while it could soon reach 100% in the US. The IMF calculates that for the world’s largest developed economies, the ratio is already over 100% of GDP. So why pick on Greece as the focus for global sovereign debt concerns? After all, the Greek government has unveiled an austerity package of tax increases and spending cuts that promises to get the budget deficit down to 2.8% of GDP by 2012.

There are 3 reasons why Greece stands out as a basket case:

1)      Tax evasion by companies and individuals in Greece is rife. This is why the austerity revenue raising measures focused on indirect taxes such as petrol and alcohol duties which are regressive and hugely unpopular.

2)      Greece did not experience sufficient structural reform before joining the Euro. The public sector is bloated – in a country of 11 million people, 1.5 million work in the public sector! In addition, pensions and retirement ages are very generous and the labour unions remain very powerful. It is now clear that Greek membership of the Euro was rushed and that the real state of the public sector finances was hidden by “creative” accounting by the previous government.

3)      Greece is a member of the single currency and therefore cannot use the traditional weapons to reflate its economy and lowering its public debt levels in times of crisis; namely, devaluing the currency, printing money and pursuing lower interest rates. All of these weapons are available and are being deployed by the UK and the US for example.

This is a deadly cocktail – there is no example of a country addressing huge fiscal deficits without economic growth as it is growth that stimulates tax revenue and reduces the need for public spending.  How Greece or anyone can believe that fiscal austerity measures alone will stimulate growth when faced with structural impediments and the complete lack of monetary policy and exchange rate flexibility is absurd.

Myth Number 2 – there is support in Greece for the measures being undertaken by the Greek government.