Starting point key question on Greek deficit goal

 

Greece may hit its target of cutting the budget deficit by 15 billion euros this year if it can overcome public opposition and avoid a social explosion.

But even this staggering achievement may not be enough to satisfy EU demands aimed at avoiding default.

Athens' plan envisions bringing down the deficit by more than six percentage points of GDP, exceeding the four points Athens has agreed with the European Commission.

This will be a condition for a 45 billion euro aid package Greece is discussing with European officials and the International Monetary Fund this week.

But lower tax revenues than pencilled in, a jump in social costs tied to rising unemployment and higher borrowing costs mean those cuts will probably not be enough to hit an original target of an overall deficit of 8.7 percent of GDP.

And that leaves out of the equation the possibility that social unrest could sabotage the best laid plans.

The main reason for the mismatch is that, rather than a jumping off point of last year's deficit of 32.3 billion euros, the recession and its effects on revenue and spending will put this year's closer to 37 or 40 billion, said Citigroup economist Giada Giani.

"They will manage to reduce their deficit by roughly six percentage points of GDP." Giani said.

"The problem is, you don't know for sure how much growth will suffer and you don't know what your income tax revenue will be. The starting point is the key question mark."

Taking the 15 billion euros in planned cuts, Giani's estimate would put the final 2010 deficit at 22-25 billion euros, or some 9.2 to 10.5 percent of GDP, assuming inflation and recession roughly cancel each other out and the economy stagnates at 237 billion euros in 2010.

That would put Greece off its path for slashing the deficit to below the EU's prescribed level of 3 percent of GDP by 2012 and slow its efforts to cut its 300 billion euro debt load.

OTHER QUESTIONS

Economists see a high risk that the effect of tax hikes, public sector pay cuts and a pension freeze will foil the government's efforts to raise budget revenues by almost 9 percent of GDP this year.

"The key risk to its target is that deeper recession will lead to lower tax revenues, offsetting some of the savings that the Government expects to make as a result of its fiscal tightening" said Ben May, from London-based Capital Economics.

Bank economists estimate an economic contraction of 3 to 5 percent this year - well above the central bank's 2 percent forecast. Unemployment also jumped to 11.3 percent in January, up from 9.4 percent a year earlier a factor that cuts into employers' contributions and drives up social costs.

Analysts said that other unknowns included the government's target of raising 1.2 billion euros in a crackdown on tax evaders and another 1 billion in savings from reworking the costs of prescription drugs in the health system.

"I can't judge the 1.2 bln euro target from cracking down tax evasion. That's a question mark for me" said Andreas Scheuerle, an economist at DekaBank.

DEBT RISK

All of this will weigh on the market's main focus - whether Greece can slow and eventually reduce the growth of its 300 billion euro debt load and avoid having to restructure or default on its obligations in the coming years.

The debt and deficit woes have prompted markets to drive debt costs to record highs in recent months, forcing Greece to pay more than usual for 28.5 billion euros in bond issuance.

But if the EU/IMF aid loans come through with their expected rates of around 5.percent, they should quell fears of skyrocketing interest costs this year, and the government has forecast only a 600 million euro rise in maintenance costs.

Whether more funds will come next year and in 2012 also remains in doubt with euro members like Germany demanding results before pledging more.

With markets still averse to lending at pre-crisis rates of around 4.5 percent, that could threaten solvency next year.

"Greece has effectively lost market access (with rates compatible with solvency) and it will probably take at least one to two years to prove the feasibility of its fiscal adjustment to the markets" Barclays Capital wrote in a note this week.

"We show around 90 billion euros of financing assistance would be necessary in a three- to four-year programme."

According to Citigroup's Giani, present deficit levels will continue to push debt levels higher from 115 percent of GDP last year by around 4 percentage points each year until the fiscal shortfall falls under 9.5 percent of GDP.

The growth in debt will decelerate each year as more consolidation takes place, but the overall load will not decline until the government brings the deficit to around 3 percent of GDP, she said.

"If they manage to get the deficit down to 3 percent by the end of 2012 as they say, then the debt to GDP ratio starts declining from the pace of 3 percentage points every year from then onwards" Giani said. "That makes a huge difference."