Tuesday, December 22, 2009

Greece, EU and more on Implicit Backing for Debt

Building on the theme of my last post, i.e., that implicit guarantees for debt are common and potentially dangerous, Greece offers an illustration of both the upside and downside of implicit guarantees.

Greece has been in the news as both S&P and Moody's have lowered its sovereign rating, from A- to BBB+ (for S&P) and from A2 to A1 (for Moody's). The harsher downgrade from S&P drew Greece's ire:
http://www.ft.com/cms/s/0/d4bdc8f2-eb13-11de-a0e1-00144feab49a,dwp_uuid=2b8f1fea-e570-11de-81b4-00144feab49a.html
Questions have been swirling about Greece defaulting and how the rest of the EU will react to potential default.

Taking a longer term view, though, Greece's debt travails are a test of the EU as implicit guarantor. I visited Greece in 1998, before the Euro came into being, to talk about valuation and at the risk of infuriating Greeks, the country was more an "emerging" than a "developed" market. The Greek currency, the Drachma, had little power outside the domestic market and Greece had a sovereign rating of BBB- (below investment grade) in 1995.

Becoming part of the EU and adopting the Euro as currency in 2002 improved the credit standing of the Greece, Spain and Portugal. While some of the improvement can be attributed to the fiscal discipline required by the EU (including restrictions on budget deficits), some of it can also be traced to the belief that the stronger countries in the EU would provide backing in the event of debt problems.

The bigger question is whether this umbrella has been a net plus for the EU countries as a whole. For Greece, Portugal and Spain, the benefits clearly have exceeded the costs over the period. For Germany and France, the effect has been more ambiguous, with the benefits of having a bigger and more prosperous market weighed off against the costs of the subsidies offered to the weaker economies. The subsidies also skewed economic activity in strange ways:
http://www.nytimes.com/2009/12/28/world/europe/28olives.html

Collectively, having one currency has made it easier for businesses to operate across Europe and those European firms that have adapted to this reality have emerged as more vibrant. While it has made Europe more competitive with the US, the big winners over the last decade have been the emerging markets, especially India and China. The biggest cost, as I see it, has been the bureaucracy that the EU has created to regulate itself and the companies that operate within its borders. In a dynamic global economy, putting more shackles on European companies will not make them more competitive.

5 comments:

Piotr Kozlowski said...

What do you mean by:
"I visited Greece in 1998, before the EU was created" ?
I guess you didn't mean EU (European Union), but Euro or the Euro Zone, right? :-)

Aswath Damodaran said...

Oops... That is what I meant to say... I fixed it. Thank you.

Rodrigo Arthur D. S. Melo said...

For 3 years im investing on Forex and Bovespa.I was studying Theology and now i ant to study Economy.

A friend spoke to me about your books. Im reading your book and he (book) is very good.

Many Thanks, you are helping me a lot

my incisive gumptions said...

Sir,
excellent article with a right vision..!

marcos bakerm said...

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