The notion that the global economic recovery has run out of steam has gained ground in recent weeks. Global activity has weakened and become more uneven, confidence levels have fallen sharply and the risk of a default in Greece has risen significantly. Economic growth in the euro area has stalled and China is trying to implement a managed slowdown in order to control inflation and the pace of housing development.
Growth estimates fall
As a consequence of these events, the IMF’s growth forecast for developed economies in 2011 was cut by 0.6% to 1.6% in September 2011 relative to their June 2011 forecast. In addition, the 2012 forecast was reduced by 0.7% to 1.9%.
Risks in emerging and developing economies currently seem slightly less severe than in developed markets, mainly because of their relatively sound economic fundamentals, especially low government debt levels.
The IMF’s September 2011 growth forecast for emerging markets was reduced by only 0.2% for 2011 to 6.4%, and by 0.3% for 2012 to 6.1%.
Understanding the problem with the euro area and Greece in particular
The southern European countries are at the heart of the euro-area debt crisis, especially Greece. The overall level of government debt in Greece went unchecked for many years and spiralled out of control. In 2010, Greece’s national debt amounted to a staggering 143% of GDP and is expected to reach 165% of GDP in 2011. The internationally accepted guideline is for government debt not to increase much above 60% of GDP. South Africa’s debt levels are around 40%.
The first bail-out
In May 2010, Greece was given a €110 billion financial-support package from the European Council and IMF, spread over 13 tranches. While this package allowed Greece to avoid a default, it included a number of fairly onerous conditions, especially the need for Greece to introduce a substantial fiscal austerity programme. In other words the government had to cut back on spending.
Unfortunately, the Greek authorities, for a variety of reasons, have been unable to fully implement the necessary spending and tax adjustments and as a consequence have run the risk of not being allocated the necessary funding from the European Council and International Monetary Fund to avoid default.
This perpetual and increased risk of default has had a major destabilising impact on the European financial system as well as on global financial markets. Because a significant portion of Greece’s national debt is owed to banks within the euro area, these institutions are facing a liquidity crisis that is exacerbating market turmoil.
The uncertainty has also negatively affected consumer and business confidence and as a result the euro area is on the brink of returning to recession conditions. There is a growing risk of the poor financial conditions and real economy (households and business sector) being locked into a mutually-reinforcing downward spiral.
The second bail-out
On 21 July 2011, the EU together with the IMF and major private sector banks designed a fairly elaborate financial support package to fully cover the financing gap in Greece. The total official financing proposed in this new package amounted to an estimated €109 billion. In addition, the private sector indicated its willingness to support Greece on a voluntary basis. The net contribution of the private sector was estimated at €37 billion.
The official and private sector support included lower interest rates and extended maturities (longer term to repay the loans) to improve the debt sustainability and refinancing profile of Greece. The EU was to use the European Financial Stability Facility (EFSF) as the financing vehicle. Unfortunately, this support package has still not been ratified by the 17 member states of the euro area and the size of the EFSF has not been increased significantly. As a consequence, the Greek fiscal position remains precarious.
The solution
Restoring confidence to the euro area will require a combination of a credible long-term fiscal adjustment programme, further pro-growth measures and an adequate crisis management framework for the euro area. This would most likely include a substantial expansion of the EFSF, a significant write-down of Greek debt, and a recapitalisation of weak banks.
A default of Greek national debt would have severe repercussions for the Greek financial system, especially the banks, as well as the banking system within the Euro-area.
The war of words
Currently the world appears to be operating on two time scales. One is the real-time environment in which the financial system operates. The process of adjustment is extremely rapid, with markets reacting very quickly to new information.
Then there is the second scale, which is the painfully slow environment in which legislative processes operate. In both the euro area (17 different governments) and the US (divided Congress), the lack of clarity and conviction on solving the crisis means the major economies are slowly rolling towards the edge of the cliff as legislators argue with each other about who gets the front seat. This slow and largely ineffective government response to key economic issues, especially in the euro area, continues to compound the global financial crisis.
IMF International Monetary Fund