Taking hard decisions: Stumbling towards Emu

GREECE: A SUPPLEMENT TO EUROMONEY/DECEMBER 1997

Recent weeks have not been easy for Greece. The first nine months of the year were marked by booming markets and optimism about the country’s place in Europe. The economy was flourishing. The government was popular. But since late October, little has gone to plan.

The greatest problem has been the recent bond-market crisis which may have sustained repercussions. And then finance minister Yannos Papantoniou announced a belt-tightening “budget for convergence”, designed to allow Greece to qualify for European monetary union (Emu). It has had a mixed reception.

The recent problems do not spring from economic fundamentals. This is one thing that most people agree on. GDP growth, forecast at 3.5% for 1997, remains fairly strong. So what did start the turmoil? At this point, opinions diverge. The international crisis triggered by events in Asia is an obvious starting point, but there are other reasons: the liquidity shortage in the bond market, over-exuberance in the stock market and, possibly, speculation against the currency. However, there is one recurring theme: Greece’s strange position of being both a member of the European Union and an emerging market. “We are on some level in between,” says one analyst. This has been cited as a reason for volatility. The country has much to do if it is to join Emu, but the benefits could be huge if it gets there. And the most important result of this is the government’s commitment to a hard drachma policy.

The government of prime minister Costas Simitis is committed to joining Emu. This was underlined by the budget on November 12. Described as tough, Emu-conscious, and optimistic, it included widespread tax rises. “It is definitely an economic rather than a political budget,” says Maria Kapetanaki, senior analyst at Sigma Securities. One crucial decision was to keep the drachma out of the exchange-rate mechanism before joining the single currency in 2001. This policy has led to some doubts that the government really wants a strong drachma to join the single currency. “They may feel it necessary to devalue just before going in,” says one trader. “A hard-drachma policy is all very well, but the currency may prove to be too high nearer the time. This way they have kept their options open.”

Another trader feels that after the recent crisis interest rates may stay high for some time. “The government might as well keep the drachma high. If they devalued the drachma everything would fall out of order. The budget is based on a high drachma. It’s the cornerstone of the Emu policy.”

But Manos Drossatakis, analyst at P&K Securities, is not so sure. “As long as the drachma is overvalued, there will be a problem with demand from abroad. The high degree of volatility will continue, and investors will continue to stay out of the market.” He cites the 10-year treasury bill’s spread over Bunds: “The bills are up around 400 basis points. Of that, 360 is currency risk, and still nobody wants to buy.”

Few others agree. Manolis Xanthakis, president of the Athens Stock Exchange, is adamant that the policy is the right one. “This talk of devaluation makes me angry. The government has to fight to decrease inflation and bring down interest rates. And it must win.” At the moment, winning the war on inflation may not make the government many friends.

A key factor for 1998 will be the relationship between the government and the unions. One analyst says: “The Simitis government has so far been tough with the unions. It has driven them down. The farmers’ union has lost credibility. It used to have a lot of clout.” The most notable measure in the budget is a cap on public-sector wages. The government’s salary bill will rise by only 2.5%, the target level for inflation at the end of 1998. The current figure for inflation is 4.7%. “We knew that they were going to decrease the wage level,” says Solon Molho, analyst at Telesis Securities. “But this was much more than we expected. I didn’t think that they would be able to go below 4%. It’s a pretty incredible decision.” And it has sparked much criticism. The week of the budget there were several demonstrations.

One banker is musing on the changes in Greek society. “Things here are definitely different. I mean, look at this.” He points to a student demonstration in the street outside. “This sort of thing used to be more common, and have much more effect. The unions had power. Now nobody really pays too much attention.” The students march on, complaining about their poor employment prospects and high cost of living. Riot police shadow the demonstration, always a street or two away. The event passes without any confrontation and fails to make the local news.

But the day after the budget, protesters were back on the streets in force. Unions voiced their discontent, adding their criticisms to those of the opposition parties. The 2.5% pay increase and tax increases were attacked for damaging ordinary citizens. This time the demonstrations made the front pages of the Greek newspapers. The press made much of Simitis’s election pledge of no new taxes.

Ironically, the new taxes were aimed mainly at the financial sector, with a charge on bond interest payments. Finance minister Papantoniou was dubbed Mr Grab-it-all. But the financial community welcomed the budget. “It is hard, but necessary,” comments one banker. “By Greek standards it’s a tough budget,” says Michael Papparis, manager, treasury & capital markets, at HSBC Midland. “We’re not used to them. But this is the price you have to pay to be in Emu.” Another argues that “this government has made progress in educating the Greek people in economics. There is more understanding of policy and implications, and less rhetoric.”

Then, on Friday November 14, 5,000 police officers in uniform marched through the northern city of Thessalonki, demanding, among other things, higher wage increases. One placard read: “Today march, tomorrow strike.” According to one banker, around 80% of Greeks still think the government has the right economic policy and that for the first time the majority of Greeks believe in the drachma. That may be true. But opposition to fiscal austerity seems to be widespread and deep-rooted.

Other optimistic forecasts in the budget include a budget deficit-to-GDP ratio of 2.4%, down from the current level of 4.2%, and an unemployment target of 9.2%. As Panayotis Thomopoulos, deputy governor of the Bank of Greece, points out: “The government has reduced unemployment to single-digit figures [the rate now stands at 9.7%]. It sounds better. There is a psychological effect.” Katerina Ferentinou-Simou, product development manager at Barclays in Athens, says: “1998 is going to be a crucial year. We need to hit those figures.”

So the Greek government has taken the tough road to Emu with a hard budget. But have the economic fundamentals been affected by recent problems and the government’s response, such as the high interest rates? Most analysts believe not. Papparis of HSBC Midland says: “High interest rates don’t have the same effect in Greece as they do in other more developed countries. Mortgages and hire-purchase are only three years old. The number of borrowers is very small. The wider public hasn’t got much debt.” The main negative effect of high interest rates has been the recent slump in the Athens Stock Market.

The government raised interest rates to prevent speculation on the drachma. But even so it spent over $2.5 billion defending the currency as the drachma lost value in the wake of the south-east Asia currency devaluations. Some bankers do not accept the idea that there was a wave of speculation against the Greek currency. One argues that it was just a few speculators testing the water. Another believes that there were simply not enough players holding drachmas to speculate with, and believes that the high borrowing rates warded them off.

But one analyst claims that the liquidity crunch was sparked by overseas hedge funds. “The finger has been pointed at a few of these funds,” he says. “They were toying with the lack of experience of the monetary authorities in handling flows. Of course it all began with the international crisis, but there was no real reason for it to spread to Greece.” However, few are willing to corroborate his story. The mention of hedge funds draws blank looks on most faces, along with a shrug of the shoulders or a denial.

However, the budget and currency problems have not put a stop to infrastructure development. The projects that were intended for the 1996 Olympics and were stalled as Atlanta won the right to stage the games have been kick-started for 2004 when Athens will be host. “Around 75% of the building was completed anyway,” says Christopher Sardellis, chief economist at Bank of America. “But other projects that were made up years before now have a goal as well.” The Athens metro extension from one to three lines should ease congestion and pollution. Several road developments, including an east-west highway, are on course. Rail links with Greece’s Balkan neighbours are being revamped. And Athens is set to get a new airport.

The Bank of Greece’s Thomopoulos puts developments into perspective: “When I came on holiday to Greece 10 years ago [from an overseas posting], I came by boat. It took 38 hours. Now the new boats take 19 hours. This shows the kind productivity advances. Successful Greek companies are modernizing, increasing in quality. There has been a jump in investment.”

Whether Greece can stay on course in 1998 remains to be seen. But the groundwork is in place. Sardellis adds: “There is the political will [for Emu membership]. They could do it fast; the market is there.” Another commentator says: “We have to be in Europe. It’s as simple as that.”

But getting there may be no simple matter.

Bond crisis speeds up reform

A new debt office, a move to primary dealership, the start of electronic trading and the auction of treasury bills. These are four reforms pushed to the front in the aftermath of the recent bond crisis

There are various explanations as to why and how the crisis started. What is apparent is that the supply of bonds greatly exceeded demand. The government’s heavy borrowing requirement in September pushed up supply just as demand began to bottom out. One analyst suggests that the increase in US floating-rate notes took some foreign investor interest out of the country. Certainly many investors have been closing their positions for the end of the year. As the international crisis has left its mark, the perception remains that Greece is an emerging market despite the nation’s planned entry into Emu in 2001. Along with the apparent overvaluation of the drachma, this adds up to a loss in confidence in the Greek capital market.

At the start of this year there was a market rally, with a flattening of the yield curve until May. From May to July yields rose again by around 1.5% on three-, five- and seven-year bonds. Then in September two large treasury-bill issues expired. The government injection of liquidity was only temporary and was insufficient to deal with the heavy borrowing requirement for the end of the year.

Maria Kapetanaki, senior analyst/trader at Sigma Securities, says: “There was a lack of interest, low prices. It turned into a snowball effect. The speculators had nothing to lose by attacking the drachma.” The crisis may have started in the bond market but it did not take long to spread to other areas. As one banker explains: “This is a bond crisis, not a foreign-exchange problem. There is a liquidity problem, which has spilt over into foreign exchange.”

But one banker is doubtful: “The bond crisis was the by-product of a well-orchestrated liquidity squeeze. Certain hedge funds thought that they had found a hole in the system. This is the first time for Greece.” The government may have won this time but the perception remains that the drachma is not the strongest currency. Hence the refusal of the government to join the European exchange rate mechanism, staying out until 2001 when it is hoped Greece will join Emu.

This may be the best policy. Although the government spent $2.5 billion defending the drachma, it won. The victory may prove to be more than just psychological. As Telesis Securities’ analyst Solon Molho says: “Compared to the effect of a devaluation, the damage of the crisis has been minimal. Devaluation would have been a major disaster.”

Perhaps the crisis will be the best thing that has ever happened to the domestic bond market. According to one economist: “It has pushed the reforms suddenly to the surface”. There are four main changes: a new debt office, a move to primary dealership, the start of electronic trading and the auction of treasury bills.

The auction system will be the first to come into effect. Previously the interest rate for the bills was administered by the government. The move to auction will also affect the FRN market. FRN coupon yields are based on the most recent 12-month treasury-bill rate plus a spread depending upon the length of maturity. The first treasury-bill auction caused an overshooting of interest rates from 9.7% to 11.3%. With an injection of liquidity, the interest rates should come down. But the system will create a more unpredictable market as well as reflecting market conditions more closely. And in the current difficult climate, uncertainty is the last thing that the government needs. However, it is still seen as a positive move by market participants.

Another positive step is the move to a system of primary dealers. Under this several banks will be obliged to buy a set amount of government bonds at each auction. In return, they will receive privileges including preferential access to the repo market. However, if the market for government debt is simply not there, all this will do is push the problem onto the banks, which in turn may seek government help if they are in serious trouble. Several banks are either fully or majority owned by the government.

One analyst says: “The system at the moment is not that far away, except that clients submit bids through the local guys. It is not going to be that great a difference, except there will be the extra risk of a commitment to a certain amount. The thing is, five or six banks absorb the crunch anyway. They step in at bad moments. Now they will get the benefits too, which is fair”

But another trader is more sceptical. “The primary dealer system? No-one wants to be a primary dealer. The idea is sunk. Let them bid. I wouldn’t.” However, there are banks ready to join the system, including Alpha Bank and National Bank of Greece.

The establishment of a new debt-management office will free the Bank of Greece from the responsibility. The office, which has a mandate to issue debt and is accountable to the finance ministry, will choose auctions and issue instruments as an independent entity. It will have four departments: for issuing paper, for evaluating proposals to set prices, for research to monitor the market and for foreign debt. The office is modelled on the Irish and Swedish ones.

Some are sceptical of its effectiveness. “The ministry doesn’t have the right personnel,” says Panayotis Thomopoulos, deputy governor of the Bank of Greece. “Civil servants and tax administrators are not capable. What we really need is a strategic think-tank.” Although some debt-office staff will be from the markets, Thomopoulos says: “I don’t like the way it is set up. It will be two parts of the Greek administration doing the same thing. It is a waste of resources, financial and human. One huge debt office will turn into a bureaucracy. It won’t be flexible.”

When asked about the new set-up, one banker begins by giving the standard line: “It is a very positive move. It will help the government borrowing terms and should be manned by experts.” He then laughs. “To be honest, who knows? Maybe the whole thing will be sabotaged by civil servants.” One trader is also cautious. “It depends if it is closely managed by the finance ministry. It may all become too political and not be focused on macroeconomics.”

Theodorus Karatzas, governor of the National Bank of Greece, warns against passing premature judgement on the office. “It needs time to mature, to create its own tradition of work.” And he dismisses the notion of conflict or sabotage.

Another development will be the move to an electronic bond-clearing system, which should help secondary-market liquidity. “It will fit nicely with the primary-dealership system, facilitate securities lending, repo and reverse repo,” says a banker. As with all new procedures the market will take time to adjust. And straight after a crisis may not be the best time to introduce a system that changes from a “blind” trade to one where the counterparty is known.

Thomopoulos of the Bank of Greece is sure the bond crisis would have been less deep had the electronic trading system been set up in September, as he had wanted. “But we were unable to install the system. Why? Because we couldn’t hire the people. I couldn’t hire just 12 guys because the government have refused to recruit new people in the public sector as part of their fiscal policy.” He shakes his head.

After the gold rush

The stock-market boom is over but the outlook is optimistic. Privatization continues, a new derivatives market is being developed and closer links are planned to other Balkan exchanges

The ASE has not been immune to the problems affecting the major centres of Asia, New York and Europe. After a phenomenal rise in the index since the start of the year, the ASE is dropping fast. The general index had hovered between 750 and 1000 points for two and a half years. From January this year, it rose from around 900 points to an all-time high of 1800 in September. Investors were delighted. Then came the international crisis. By November 13, the index was at 1373 points, and earlier in the week had suffered a one-day fall of over 5%.

But the international problems were not the whole story. One of the effects of the bond crisis was the high level of interest rates. “Investors could get an overnight return of 150%,” says one trader. “Of course, they fled the market. I’m sure they will come back.”

The fall was not unexpected. “Before the crisis we were expecting some correction or consolidation,” says a securities analyst. “The rise couldn’t last for ever.” Others agree: one economist called the correction “healthy”. And now it seems the worst is over. Perhaps.

If the high level of interest rates continues, the exchange will continue to suffer. To complicate matters, three Greek banks raised deposit and lending rates, causing a further one-day fall of 3.9%. But ASE president Manolis Xanthakis remains bullish about the market’s prospects. “If it goes down, it will bounce back up again. That is what stock markets do.”

The exchange is looking to the new year with optimism: the government will continue privatization, the exchange will create a new derivatives market and plans closer links with other Balkan exchanges. Future success seems to depend on whether the earlier success of the market proves to be a solid foundation.

There were several reasons for the steep rise earlier in the year. The ASE flourished on the back of the bull markets around the world. Greek government bonds became less attractive to domestic investors and money poured in to the stock market. The profitability of listed companies was high, the Greek economy stable. And the mandate for the 2004 Olympics gave an added feel-good factor.

However, the number of companies listing in Athens has tailed off: after the rush of listings in earlier years, only 15 companies have come to the market so far this year, and only 16 in all of 1996. The total is now around 240. Xanthakis is unconcerned. “I don’t care about the number of companies. If the listed firms become bigger they respond in new ways, improving efficiency.”

The tail-off in the number of companies is not necessarily a problem. There are not many new listings because most companies have joined. Corporate activity has slowed down. There will be some new listings from the privatization programme. But how much of a success is the sell-off?

It took a lot of time and effort to bring telecoms company OTE to market. It was sold in several stages; the share price consistently underperformed the market. Perhaps the extraordinary bull run did not help. But for a major privatization and one of the most profitable telecoms companies in the world, the performance has given worrying signals. As one securities analyst notes: “OTE was the biggest issue ever in Greece. The problem is not the quality of the stock. Blame it on the size. Many foreign investors had OTE in their portfolios and were reducing their exposure to drachma equity.”

In the privatization programme there are plans to sell stakes in the duty-free shop, and, more important, in the petroleum company. The 10% issue of the latter should raise around $40 million but in the government budget this has been accounted at only about $25 million. “Perhaps they have stashed some of the money elsewhere,” jokes one analyst. Or perhaps the government is not expecting the issue to be such a success.

Despite the setback, most commentators feel that the privatization programme needs speeding up. One of the initial problems with the OTE privatization was the reluctance of staff to accept the changes. The previous government had wanted to sell 49% of the company. The step-by-step approach of the Simitis government, though slow, has been more acceptable. “Now there is more awareness in the company of the new owners,” says one banker. Panayotis Thomopoulos, deputy governor of the Bank of Greece, says: “There has been a change in the public perception of privatization. It is now ideologically acceptable. Psychologically, privatization is the key. It could and should go faster.”

The ASE is also set for a new derivatives market, based in the same building as the exchange. Xanthakis believes the new market will give investors the flexibility they want. The upgraded system will also deal with equity and bonds. “This will provide investors with a package: parallel transactions of all three products.”

But new systems and markets have an inherent danger. There is a lot that can go wrong. Without thorough testing, the new systems could create more problems than opportunities. Xanthakis says that all the necessary precautions have been taken and there will be efficient risk-management.

There is still room for caution. One banker emphasizes that the market needs time to digest such developments. An analyst says: “The derivative market next year is a very popular move but some people are understandably cautious. In derivatives, the sum total is zero. If one person wins, someone has to lose. With stocks we can all make money.”

The derivatives market is not the only change at the ASE. It has begun to modernize by assuming control of personnel from the government. It is also looking to improve cooperation with neighbouring markets. There have been meetings with representatives from several Balkan countries. Romania and Bulgaria are regarded as the nucleus but inclusion is not limited. “We want to join forces in a creative way,” says Xanthakis. This may take the form of a joint index of the top-performing stocks. “We are finding the solutions first,” says Xanthakis, “and by Christmas we will announce specific things”.

However, not everyone is convinced that an index of this kind will be so useful. “You have to ask who is going to follow it,” says one trader. “I suppose some overseas investors may be tempted. But at the moment, they are consolidating after the crisis. I can’t see any projects being an immediate success.”

Greek banks, new and old

The message to Greek domestic banks has been clear for a long time: merge or face extinction under the impact of a single European currency. But for all the talk of consolidation, not much progress has yet been made. The government still retains a high stake in many banks, and has made only small moves to sell its holdings. But even so, most people feel that by 2001 there will be no more than four or five major banking groups in Greece, down from the present 25 or so. The main candidates are the Alpha group, Ergobank, and what is loosely termed the government group. National Bank of Greece, which is still the country’s biggest bank by a clear margin, leads the field. But one newcomer which may yet be a surprise member of Greece’s emerging banking elite is EuroMerchant Bank, now known as EFG Eurobank.

The bank, described by competitors as profitable, well run and ambitious, was started in 1990 by the Latsis family which owns several banking operations throughout Europe. The family is also involved in other business activities, notably shipping, and this has caused a little tension. You get the sense that Eurobank, the family’s seven-year-old Greek baby, doesn’t like being told what to do by its parent. Some in the bank question the extent of the founding family’s commitment to the banking sector. “They have five main activities: banking is only one,” complains one of the bank’s top men. He goes on to make a case for independence for the bank. “We are insured as a bank for bad debts.” So is the Latsis money not needed? The answer is non-committal. “The bank has a level of supervision from Swiss authorities because of the ownership. But we are operating in the Greek market.” Further questions about the role of the family become awkward, and the story is changed. “Look, they have zero influence. They are only two out of eight members of the board, which meets only four times a year. I don’t see the difference.”

But to outsiders, the success of the bank appears tied up with the family. “Eurobank is quite profitable,” says one rival. “But it had cash in the first place. It’s hard to compete with the big names. You have to find clients. It’s better to be a specialist. Essentially, you need the money.” Another observer says: “With Latsis behind it, the bank could sustain losses for a while. They allowed the bank to grow. The question is how badly the Latsis group want the bank to be big. Latsis likes the finance business. They may look to move into the Balkans ­ it’s the wild west of banking.”

So is Eurobank a force to be reckoned with? The acquisition of Interbank in 1996 seems to suggest that it is. According to both the bank and its competitors, the acquisition was a good strategic move. The two banks are complementary. Interbank’s retail business fits well with Eurobank’s strength in wholesale banking, private banking and shipping. Eurobank now has 42 branches, compared with eight at the start of 1997. The bank claims its strategy is to work with partners, to acquire holdings and also to grow organically ­ a bit of everything in fact. But so far it has worked. In 1994 Eurobank acquired 75% of Banque de Dépôts (Luxembourg), which helped expand Eurobank’s activities in treasury dealing, private banking and promoting Greek financial products internationally.

The bank is still on the look-out for further acquisitions. The rumoured takeover of Bank of Crete fell through because of problems regarding an unknown liability. “It was probably a good move to pull out,” says an observer. “Bank of Crete had some bad loans and has lost a lot of its staff.”

Eurobank has grown fast in a short space of time. Can it continue this pace of development? Those at Eurobank believe it can and that it has enough muscle to be comfortable in Europe. The staff are experienced and are from a range of backgrounds. Many have foreign banking experience, including the chief executive, Nikos Nanopoulos, who has spent 17 years in the US. But problems may arise if Eurobank tries to succeed in too many areas and spreads itself too thinly. “But then again,” says one commentator, “they can always rely on the Latsis money.”

Eurobank has certainly highlighted the need for change in the Greek banking sector. With an ambitious and original approach, it has managed to capture market share quickly. But other newcomers will be hard pressed to achieve a similar feat. “The potential market share for any new bank is tiny,” says one analyst. The reason that Eurobank has succeeded is because the rest of the industry has been slow to move forward, even though the crunch time of Emu entry is growing nearer. Bank mergers are talked about, but little practised. The only bank merger that seems likely is that of Ionian Bank and Commercial Bank which is apparently at the advisory stage.

One bank that is confident of its future is the National Bank of Greece. Governor Theodore Karatzas is proud to tell of the bank’s history: “We are the oldest continuous foreign presence in the City of London,” he begins, and talks of the bank’s other branches overseas. “We have owned Atlantic Bank of New York since 1924. We used to follow Greek immigrants abroad, now we are following Greek businessmen.” The National Bank of Greece may have a proud history, but it finds it hard to shake off its image as the government’s bank. Although the state owns only 5.11% and, since 1992, the ministry of finance no longer wields majority voting rights, the government still appoints the board of directors.

Karatzas does not take kindly to the suggestion that as he owes his appointment to the government he is beholden to them. “National Bank of Greece is private from a point of view of share ownership,” he insists. “The public sector has the majority. The government is not interfering with the bank. It is true that in the past the government used the bank as a tool of the clientele system, but things have changed completely.” The bank is in the process of modernization, creating a new group treasury that will monitor risk more effectively. It already has the largest trading floor in Greece, built in 1988. It is also merging its two mortgage-lending subsidiaries, National Housing Bank and National Mortgage Bank, which Karatzas claims control 70% of the mortgage lending market.

National Bank of Greece and Eurobank represent the two extremes of Greek banking. Just walking into their offices reveals the differences. Eurobank has a modern, shiny entrance with glass doors. The offices look and feel very efficient, and are based in a modern block in central Athens. National Bank’s offices are to the north of the city centre, and occupy two grandiose buildings on opposite sides of the street. It has impressive wooden doors and floors. The atmosphere is not so much old-fashioned as steeped in an awareness of the bank’s history.

But does either bank have a much of a future? Like most Emu contenders, there is the foreign competition to worry about. However, the presence of overseas banks is not guaranteed either. As one analyst observes: “Why have an operation in Greece unless there is a competitive advantage?” Much of the foreign banks’ activities can be done with a skeleton office and a main operation in London or Frankfurt. One banker thinks that under Emu the Greek banks will all have to concentrate on being niche players and having a retail base. “The local banks will provide the bread and butter. The sophistication will come from outside.”

But so far, the changes haven’t been made. As one banker says: “For Emu we need strong groups. Possibly next year there may be some moves. At the moment, everything is frozen after the turmoil.” The thaw can’t come too soon.