Europe

Smoke, Mirrors and Misdirection

Monday saw the latest twist of the Greek saga with reports that Tsipras’ government had, for the first time in the last five months, come up with some credible proposals. Positive noise from the more dovish of the creditors sparked a relief rally in European equities, with the Athens market up c.9% and the DAX up c.4%. Markets are making further headway today as hopes begin to crystallise that the long-awaited deal may be in sight.

As has been the case with much that has happened between Greece and its creditors, confusion – or perhaps more precisely, misdirection – has been the name of the game. Media reports of the wrong papers being sent to the technical teams on Sunday night tally ominously with Tsipras’ insistence for the process to take place at the ‘political’ rather than the ‘technical’ level. Is is simply the case that the Greek side wished to ensure that there was not sufficient time to begin assessing the detail of their proposals on Sunday, thus making certain that nothing substantive could be raised against these on Monday? If so, the theory behind this might run to the effect that by creating positive expectations in the media and the markets, it then becomes more difficult for the creditors to disappoint those expectations by reviewing the proposals in too rigorous a manner; if the headline numbers appear to be delivered, does it necessarily matter how they are reached? Isn’t it better, after all, to approach the matter from a ‘political’ rather than a ‘technical’ perspective? I think it is obvious whom we have to thank for this latest example of gaming.

But, of course, it does matter how the headline numbers are to be delivered. It matters a lot. One way, the preferred way, means structural reform and consequently a higher trend growth rate. The other way eschews such reform – which tends to be difficult to enact – in favour of short-termist  measures that not only damage long term productivity, but also negatively impact the prospect of cyclical recovery. So let’s put on our ‘technical’ hats and have a quick look at the Greek proposals.

According to media reports of the Greek proposals, the budget projections for the next two years (required to generate the agreed primary surplus of 1% of GDP in 2015 and 2% of GDP in 2016) call for the following savings: EUR 2bn from raising VAT rates; EUR 1.35bn from a ‘special’ 12% levy on corporate profits; EUR 400m from a 300bps increase in the corporate tax rate; EUR 470m from an increase in personal wealth taxes; and a further EUR 150m from a combination of TV advertising tax and a luxury tax. Summing the various tax increases we arrive at a figure of EUR4.4bn. On top of this, changes to the pension system are set to bring in a combined EUR 2.5bn, with an additional EUR 800m to come from a combination of income from VLT licences (a type of fixed odds betting terminal that is currently being rolled out), mobile telecom licences and cutting defence spending. With another c.EUR 200m coming from a variety of further measures, all in we are looking at around EUR7.9 bn of incremental govt income over two years.

The proposed changes to the pension system bear further examination given the importance placed by the IMF and other creditors on structural reform in this area. Of the EUR 2.5bn estimated saving here, c.EUR 1.5bn is from increasing pension contributions to both the main govt and supplementary schemes; EUR645m from increasing health insurance contributions in pension schemes; and EUR 360m from restrictions on early retirement. It is assumed that the cost of increased pension contributions is bourne by current employers and current employees (with the brunt of it most likely falling on employers), with the increased health contributions hitting current pensioners. It remains to be seen whether the fact that the bulk of the suggested pension measures rely on increased contributions (rather than directly cutting benefits and/or reducing the administrative cost of the scheme) will satisfy creditors’ demands for structural reform of this area.

Taking a step back, it becomes apparent that of the EUR 7.9bn in overall savings proposed by the Greeks, c. EUR 6.7bn is from increasing taxes/contributions. That’s around 85%. To get biblical for a moment, the adage “Wherefore by their fruits shall ye know them” springs to mind and what we have here is no more and no less than the usual socialist ploy of tax and spend. Only this time the ‘spend’ part of the equation is indirect, equating to Syriza’s determination to shield the public sector (and other ‘clients’) from the sort of structural reform that the country so desperately requires. As countless academic studies have shown, beyond a certain point increasing taxes is counter productive, merely leading to greater avoidance and/or ‘brain drain’. In a country where tax avoidance is part of the culture and where the incentives for the most qualified to remain are low, this is the last thing Greece needs. What Greece needs instead is to put in place the foundation for sustainable wealth creation. A key part of this must come from addressing the corruption that is endemic in the system. This can only be achieved by structural reform aimed at dismantling the various self-interests that have battened onto the bloated administrative apparatus of the state.

Needless to say, increasing taxes will also do little by way of spurring economic recovery.

If Greece’s creditors are serious about putting the country on a secure financial footing they will reject these proposals and exert pressure to ensure that Greece enacts genuine structural reform. Failure to do so will merely result in further showdowns down the line when the negative economic consequences of an intellectually bankrupt fiscal policy manifest in further missed targets and budget shortfalls. It beggars belief that a set of proposals that rely on increased taxes could be deemed credible by the very creditors that have persistently lambasted Greece for failing when it comes to tax collection.

Market reaction suggests that this is a done deal. Whilst one ignores price action at one’s peril, this looks too sanguine to me. The obvious lack of structural measures in the proposals and the overwhelming reliance on increased taxes/contributions to make the numbers work (in the context of an appalling record with regard to collection), means there has to be some reasonable chance that the proposals in their present form are rejected. This would most likely lead to renewed deadlock, deposit flight and question marks over the continuation of the ELA.

However, to engage with this scenario requires a unified political will to take the more difficult route that promises long term benefits – even if this entails some degree of risk – a will that has arguably been more noticeable by its absence than its presence in the EU’s dealings to date (an observation that has obviously informed Greece’s negotiating strategy). However, Tsipras’ cynical handling of the situation and the bad faith with which he has consistently engaged Greece’s creditors and European partners over the last five months can surely not have been lost on even the fluffiest of the EU doves. I feel that the celebratory champagne that is seemingly called for by the latest antics of Greece’s champagne socialists should, at least for now, remain on ice.

From a theoretical trading perspective, I would look to reopen short positions (if closed) on the Greek equity market (played via the domestic banks) should there be intimations over the next few days that the creditors are finding issue with the way in which the proposed budget savings are to be generated. Conversely, in the event that agreement is reached with no substantive changes required on the part of the Greeks, there would clearly be a short-term tradeable rally to be played in the Greek equity market (long exposure via the banks), with serious capital better committed to opening/increasing long positions in periphery (ex Greece) equities.

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