Update on the PIIGS*

- compiled from information supplied by UBS


The situation in Greece and other so-called PIIGS members remains unsettled and will continue to be a source of volatility for global financial markets.

The head of the European Central Bank, Jean-Claude Trichet, and more generally the central bankers and finance ministers of the main EU member countries who met this recently in Canada for a G7 summit, sought to reassure markets over the stability of the Eurozone’s fiscal position.

Trichet rightly points out that the budget position of the EU actually compares quite favourably with the fiscal status of other large industrial nations such as Japan, the UK and the US.

Meanwhile, Greek Prime Minister Papandreou continues to push forward with ambitious fiscal reform measures aimed at narrowing the budget shortfall. The Greek government has outlined an aggressive strategy for reducing expenditures and raising revenues in an effort to reduce the budget deficit from over 12% of GDP currently to just 2% by 2013. Market participants, however, remain unconvinced.

There is concern that the more vulnerable players within the Eurozone such as Greece and Portugal could pose a risk to the overall stability of the region and could even threaten the viability of the Euro.

While these concerns are greatly overdone, there is still a risk that contagion could not only ripple through the weaker players within the EU but could even pose a threat to some of the larger industrial nations with mounting fiscal problems of their own.

Latest Developments

Concerns over the fiscal crisis in Greece have served to unsettle financial markets and raised fears over the emergence of a new more virulent strain of the credit crisis that shook global financial markets in 2008 and early 2009. It is therefore important to monitor the situation in Greece for any signs that the mounting concerns over sovereign risk are having a broader impact upon financial market stability.

As at 8 February 2010:

• Finance Ministers from G-7 nations met recently in Iqaluit, Canada to discuss the current state of the global economy and fiscal imbalances. Despite concerns over deteriorating fiscal positions across every member nation, the ministers stressed the need for continuing stimulus measures to help stabilise the global economy.
• French Finance Minister Christine LaGarde endorsed the measures mapped out by Greek Finance Minister Papaconstantinou, stressing that the EU would “make sure it is managed.”
• This suggests that policy makers will place increased pressure on the Greek government to actually enact the needed painful fiscal reforms in exchange for EU support and to stick to them beyond 2010.
• Although the EU is a high-tax area, Greece actually has one of the lowest tax burdens within the Eurozone. This does suggest there is room for some level of fiscal consolidation through some combination of increases in tax rates, closing of loopholes, crackdowns on evasion, one-off increases across selective profitable industries, elimination of temporary tax breaks and the acceleration of EU transfer payments. However, with social opposition to fiscal contraction running high, these efforts may prove difficult for elected officials.
• S&P’s recently reduced its outlook on Japan’s sovereign credit rating from stable to negative. This has raised the issue of a broader deterioration in the fiscal position beyond the PIIGS.

The IMF projects that the government debt to GDP ratio of the G20 group of countries will rise from 80% prior to the financial crisis to nearly 120% by 2014 under current assumptions.

Conclusion

The situation in Greece differs from the 2008-09 credit crisis in many important respects. However, UBS share some of the concerns over the prospects for some sort of contagion that could ripple through the EU and beyond. This, in turn, could prompt further reflexive de-risking within investment portfolios and lead market participants to flee to the relative safety of dollar-denominated treasury debt. While this is a risk scenario rather than a baseline forecast, things will continue to be monitored closely for any indication that the impact from the Greek fiscal crisis is either broadening and deepening.

8 March 2010 - update

The Greek government detailed plans for 4.8 billion euros of additional cuts in an effort to manage its budget crisis. Government workers will lose some pay and taxes on a range of goods will be increased. The austerity measures were “difficult” though necessary for “the survival of our country and our economy”, Greek Prime Minister George Papandreou said after a cabinet meeting in Athens.

Papandreou told his cabinet that if the country needed aid and the EU wasn’t forthcoming, he’d consider seeking help from the International Monetary Fund, according to a report by Bloomberg News.
European officials have praised the latest Greek cuts. But so far there is no clear signal that financial help might emerge, and the European Central Bank and International Monetary Fund are insisting Greece must show it is reforming the entire structure of its economy.

However, its 5 billion euro bond offering last week was more than twice oversubscribed - fantastic news for both the European Monetary Union and global markets, especially since buyers were commercial banks and pension funds in Europe taking a long term view of Greece’s prospects..

* Note: The term PIIGS is an acronym used to refer to a select group of countries within the European Union (Portugal, Italy, Ireland, Greece, and Spain). The term is used for convenience and utilized when discussing issues common to this group of nations. The use of this acronym is not intended to convey any pejorative impression about the member nations, and is therefore not meant as political, social or cultural commentary. It is merely a convenient market convention.