Tuesday, September 21, 2010

Greece: Default is Not an Option

WSJ: The Perils of a Schizophrenic Euro Zone
Financial Times: Athens Admits it Has a Long Way to Go
Financial Times: Greece Rules Out Possibility of Default
Financial Times: Greek Stress Tests Delayed

Last week, Greek finance minister George Papaconstantinou went on visits to London, Paris and Frankfurt to persuade investors that Greece is recovering from its financial crisis in an attempt to build its credibility and persuade foreign investors to buy Greek debt. Greece has made significant changes since it revealed that it misled the European Union regarding its economic viability. On his European tour, Papaconstantinou confirmed that Greece reduced public sector wages and salaries by 15% and cut operating costs by 50%. In spite of these changes, an IMF report released on September 14, 2010 revealed that Greece still needs to improve tax collection and control spending in order to bring its economy to a sustainable level.

Papaconstantinou admits that Greece still has a long ways to go, and restructuring its debt is not an option. He stated that "if Greece restructures, why on earth would people invest in other peripheral economies? It would be a fundamental break to the unity of the euro zone." And with the support of the euro zone and the International Monetary Fund ("IMF"), it is seems unlikely that Greece will default. Some economists are now accusing investors of overestimating risk in the Greek investments. (See EU Commission: Fears of Greece Debt Restructuring Unfounded.) However, the IMF is sending mixed messages, arguing that the risk of Greece defaulting is overestimated, but that Greece has so much public debt that in order to stabilize it, the country will have to make greater financial adjustments than it has ever been able to produce. With so little stability, it is understandable that investors have been reluctant to invest in Greece again.

EU policy makers are in a bind; they need to encourage investors to invest in all euro zone countries and show that it is safe to invest in countries like Greece. However, with such high debt and low potential for growth, the only way to convince investors that it is safe to invest in Greece is for the EU to extend a bailout guarantee. The EU does not want to do this, as it would be politically unpopular, particularly for taxpayers in more stable countries that would have to fund the bailout. But the international community is doing as much as it can to help Greece. On September 19, for example, the IMF, European Central Bank and the European Commission announced that they would postpone the stress tests for Greek banks, which will examine the solvency of Greece's banking sector. This postponement will allow Greece additional time to recover and reap the potential benefits from the €1.7 billion in capital that the Bank of Greece has raised, which should improve confidence among investors.

Discussion Question: Has Greece done enough to ease the minds of investors who are considering investing in Greece or purchasing Greek debt?

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