Inside investment: Greek lessons
The Greek economy has been more than the sick man of Europe; it has been a standing joke. But the discipline imposed by membership of the EU has forced the necessary adjustment and the future is beginning to look brighter.
It can be argued that the Greeks invented good government. (And they were not bad at mathematics, philosophy and drama either.) One need only point to Aristotle’s Ethics or Plato’s Republic and Laws. Perhaps the geography of Greece’s disparate islands and towering mountains, which made the division of the country into city states logical, played a role in this.
Both Plato and Aristotle felt that achieving personal happiness involved being good citizens. This was best achieved when everyone knew one another. Plato believed that the ideal state had just 5,040 citizens. Modern Greece is not often held up as a model of good government, however, even though its population of 11 million is relatively small.
The stock market more than reflects this small scale, trading at 4.1 times earnings – just between Argentina at 3.2 times (11% of GDP) and Russia at 5.9 times (28% of GDP) – with a market capitalization of about 18% of GDP. At the other extreme is the US, with market capitalization of 115% of GDP. I mention this point because in the old days, 20 years ago, we used to view emerging markets as a bargain when they got down to 25% of GDP.
Of course, the European Union and open economies tend to make such rules of thumb less reliable, but it is still true to say that the Greek market is very cheap, despite have risen 28% over the past year. The value is depressed in part by a 10-year bond yielding 10.5%, and the stock market is probably unlikely to rise much more until investors begin sensing a reduction in rates. It is the reverse of the financial repression happening in the US, UK and Japan, where artificially low bond yields force investors into riskier assets.
So how is Greece doing? The Troika of organizations supervising Greece, which includes the IMF, the European Central Bank and the European Commission, is currently conducting a review of the Greek financial support programme, and the country is getting good grades. The preliminary second-quarter GDP data unexpectedly showed positive growth on the first quarter – the first quarterly rise in five quarters – leading the Troika to forecast a 1.3% primary surplus this year with a 1.5% overall budget deficit.
A gruelling diet
I had previously been of the opinion that Greece would not stay in the eurozone. For some reason, though, it has remained, probably because it did not dare leave. Because of this, the fiscal situation has improved dramatically. If you lock someone in a room and feed him only a meagre diet of thin gruel, he is bound to lose weight. Unable to borrow or to print money, the Greek government could not pay salaries or fund deficits without the Troika, so the Troika set the rules of the game. Unit labour costs dropped 13.7% between 2009 and 2012, and government employees were reduced in number by 15% from year-end 2010 to year-end 2012.
The rules worked and the economy has started growing again. Problems abound, however. The good news is that tax revenues are only about 30% of GDP, so more revenues are possible, since many EU countries are closer to 40%. The privatization plan is moving slowly because of political opposition, with the electricity and gas companies, the ports and other entities in line to be sold.
Bids are scarce. But privatization is not important for the revenues to be generated by the sales, which are expected to be only about €25 billion over the 10 years ending 2021 compared with an annual government budget of about €80 billion. Rather, the privatizations are expected to increase the efficiency of the Greek economy and reduce financing requirements. Labour costs have become competitive and the tax system has been rationalized. Land, not just buildings, will be subject to property taxes under a new law, which is expected to encourage more efficient land use by raising the cost of leaving it idle.
Greece’s national debt is high at 175% of GDP, but will drop to 120% in 2021, if everything goes as planned. Prime minister Antonis Samaras is optimistic. He recently said: "According to most (experts), we will not need a couple of decades, not a couple of generations, but only six years to get back (to) the pre-crisis levels of our standard of living and GDP." This is good news indeed.
The euro has shown itself to be an effective way to enforce financial discipline on a government. The US, the UK and Japan, to name a few, have been yielding to the temptation to create money, something countries such as Greece and Ireland have not been able to do. This has forced the implementation of reforms that could not otherwise have been made, and these economies have consequently become much more competitive.
It will be interesting to see how long the currency-printing countries can continue on their present course without triggering a market reaction. One hopes they will adjust their policies with perfect foresight. If not, the first ones into the crisis might well be the first out.
Both Aristotle and Plato believed in dealing with important affairs of state through self-discipline, a spirit of moderation and persuasion. That might have worked in the time of small city states, at least occasionally. But in the modern world we operate on a larger scale, and the hand of a strong leader is necessary. Fortunately, Greece has such a leader and she is going to be around for another four years: Angela Merkel.
Lincoln Rathnam, PhD, CFA, is an investment professional based in Singapore and Boston. In a career spanning almost 30 years he has managed equity, debt and venture capital portfolios and was a pioneer investor in emerging markets in the late 1980s