Sunday, May 16, 2010

Rise in European Public Debt: Suffocating the Private Sector whilst it is on CPR

I fear that the EU has merely kicked the can down the road and whats worse is that Greece is getting no where to solving its actual problem and so is Spain... Anyway Greece first... The 1 Trillion USD rescue package seems to have restored calm and hopefully stopped a contagion...but I fear that the broader effect is that the ECB and Governments in the EU are de-railing the efforts to start off the real economy! 

I feel that all the EU is doing is shifting the problem around from the banking to the government sector. As CNBC reports rather correctly, Having taken the burden off the banks and the private sector in recent years, the focus on sovereign debt will simply see the burden transferred back to the private sector. As Monument Securities points out "The EU and the IMF sought to meet the threat through what, in essence, is yet another exercise in shoveling troubles away from those areas where the markets are looking towards less intensively-observed sectors of the financial system."

Greek Solution or ?: The IMF and others seem to have identified correctly that Greece and the PIGS in general need to make structural adjustments to their economies to make them more sound. But the solution for Greece is at best a partial one and may not be required in that intensity... Greece, Spain and Portugal have begun the process of cutting spending... Greece is planning a minimum 9% cut in spending...

Barking up the wrong forest? Here lies the problem. Greece needs to boost revenue collection in addition to rationalizing spending. That is going to happen if and only if Tax regime is revamped and the uncompetitive structure of Greece'e economy visible in terms of family controlled businesses is changed quite a bit. Spending cuts and no revenue rises will complete a deflationary double whammy for the Greek economy and may do so for Spain too. The spending cuts alone will reduce domestic demand that will follow from budget-cutting measures in these countries diminishing the tax base and increase the cost of social transfers.

The Result? Fiscal adjustment will shift the burden of debt back to the private sector and the banks reversing the stimulus of Fiscal 2008-09. Since the banking sector has yet to address many of the problems like the bad loans that led to the crisis, moving debt to the private sector could be disastrous for the industry.

I agree with assessments that the conditions for sustainable growth will only be restored after prolonged deleveraging, with final demand running below supply, in the debtor countries.

Simply put, Greece will have to

1. Rationalize Spending (rationalize on indexed pensions and atrocious civil service benefits)...donot reduce

2. Enforce tax code (Focal Point, This is a sina qua non condition)....donot drive capital away (afraid already a lot had left Greece)

3. Boost Competition in business (Greek business is notorious for stifling innovation and competition)...dunno how this can be done though!!!...private sector is the key

Points 2 and 3 should be prominent and not point 1. As of IMF and co have focused on Point 1. You cannot suffocate a person when you are giving him CPR....

The following schematic should help further understanding.... it is crucial to use economic theory to show why the above arguments are important.

Courtesy: New America

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