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Victoria Mindova

Gikas Hardouvelis is one of the most influential financial analysts in Greece. Eurobank’s chief economist and a professor at the University of Piraeus, he was an economic adviser to Prime Minister Lucas Papademos, who headed a three party coalition government from November 2011 to May 2012. In a conversation with Victoria Mindova, he hides neither his disappointment in the state policy towards the Greek banks, nor, however, his optimism that Antonis Samaras’ government has a chance to correct the mistakes of the recent past.

Greece has adopted the fiscal adjustment measures and the budget for next year. The bailout, however, is late. Why is that?

The bailout is late because the supervisory Troika’s report on the development of the reform effort is late too. The report itself has been delayed also because there is a disagreement between the International Monetary Fund and Europe on whether there should be a second haircut of the Greek debt or not. This is the so-called OSI (Official Sector Involvement) or the debt that the official sector holds. The Greek government at the time of Lucas Papademos insisted on OSI. The Europeans did not want to reach into their pockets to grant more money and so a middle road was found last February, when Greece implemented the PSI (Private Sector Involvement).

Now, the problem is back, because the Greek economy has shrunk more than the lenders’ plan anticipated. We do not know how it will develop and what kind of compromise will be worked out. We will wait for the formal report by the supervisory Troika.

So far, the lenders have not accurately forecast the impact of recession on the Greek economy. The austerity measures have had a much larger negative impact on economic development and the economy cannot withstand more pressure.  Of course, it is not easy for the lenders to say, "Give Greece more money," because the country did not perform its duties on time in the recent past.

Greece may now have satisfied its obligations and may have adopted a law including all the measures under the bailout agreement, but the other counterparty, that is, the 16 Eurozone countries and the IMF, no longer trusts us so easily.  Greece will receive the promised aid in the end, but it will not come quickly.  Greece needs liquidity to emerge from the recession. As an economist, I think that many of the present fiscal adjustment measures should take place later, over 2015-16, and that the European money should arrive faster. For the time being, however, the opposite is happening - fiscal consolidation measures are being taken first and the funding comes afterwards.

Is it likely for Greece to default on Friday, when the bond loan of five billion euro to the European Central Bank will mature and the country has not yet received the financial aid?

No, there is no such danger. The Ministry of Finance will again issue short-term T-bills to raise the necessary funds to cover the maturing bills.

Was it an information trick the warning by Minister of Finance Yiannis Stournaras that if Greece did not vote the measures by the beginning of November, the country would not be able to meet its needs and was likely to default?

No, it was not a trick.  It is the reality. For example, the maturity of the T-bills issued in August takes place in November. This necessitates the issuance of new short term T-bills in order to pay off the old ones.  But to issue new T-bills the ECB has to give the green light.  In addition, arrears of the State sector towards private sector providers are increasing, depriving the market of much needed liquidity.   Exporters are also facing immense liquidity problems.  Healthy companies are pressured. This liquidity will not come unless the new measures were voted. Remember also, the Greek state is still running a primary deficit and the liquidity constraints in the private sector will not be resolved without a recapitalization of the Greek banks.

Will there be a new debt restructuring, and if so in what form? Will it be in the form of new cuts in the value of bonds held by private investors (new PSI) or in another form?

In 2013, we will enter the sixth year of recession. Therefore, the debt as a percentage of GDP is still growing. The larger part of the Greek debt is now in the hands of European countries and the International Monetary Fund. This means that if there is a new debt haircut, it will depend on decisions of European leaders and the International Monetary Fund.

Whether the debt is sustainable or not depends on whether the Greek economy can pay the interest rates on that debt. If Greece starts to produce a primary surplus in 2013, then it will be able to pay the interest. When we emerge from the recession, debt servicing will no longer be such a big problem. What will remain a problem, of course, will be the size of debt, which will be hanging as a Damoclean sword, always reminding investors the default possibility. Thus restructuring or some other sort of financing may eventually occur.

Do you expect a restructuring of the Greek debt in 2013?

Politically it is extremely difficult for Europe to adopt a similar restructuring to PSI and so soon. We may, however, see a tiny reduction in debt from lower interest payments.  I do not see a bigger restructuring just for Greece. If a bigger restructuring is undertaken, it will be a general restructuring of debt, not only in Greece but also in other countries, as for example recapitalizing European banks directly through ESM and not via state funding.

Does this mean that we will expect Europe to provide a general solution to the debt crisis?

For the time being, we can expect some minor changes, but as time goes on, a more permanent solution will be seeked.   In general, EMU needs deeper integration and a restructuring may be part of that integration process.  Yet, it is hard to forecast political developments.

You and other economists say that it was not the banks that caused the crisis in Greece, as had been the case in the USA in 2008. It was the result of a government policy, which affected the financial sector. My question is, why were banks buying Greek government bonds for years while the foreign debt was growing and approaching unsustainable levels?

Greek banks did not hold so many government bonds as, say, Italian banks held Italian government bonds. The majority of Greek government bonds were outside Greece.  Banks hold government bonds as part of their diversification strategy.  When the crisis began, domestic banks had an additional moral obligation to help the State with its liquidity problem.  Of course, this "help" proved fatal due to the PSI, which forced the banks to write off almost all their capital.

Ten months after the restructuring of the Greek debt, the PSI (Private Sector Involvement) could you make some assessment of the advantages and disadvantages of the process?

As an economist, and before the implementation of the PSI, I was saying that debt restructuring should have been implemented in a different way. In my opinion, it should have been undertaken in a way that would not affect the banks so much. Until then, banks were still a healthy sector of the Greek economy. The alternative of the so-called Brady bonds had been tested in the past and proved effective in other countries in Latin America.  The Brady bonds involve a swap of 100 face value of old bonds for 100 face value of new bonds, but at an almost zero interest rate and with lengthened maturities. The state might not reduce the debt so much on paper, but it would be easier for it to finance it because it benefits from the zeroing of the high interest rate over the coming years. If the debt had been recorded in the accounting books of the banks with its face value, not with the current market value of the bonds (which can easily be decided at European level), banks might not have recorded such large losses. Currently, the four major banks in Greece are registering losses of approximately 24 billion euro as a result of the debt haircut. If Brady bonds had been used, recapitalization of major banks could have been avoided. Furthermore, because the restructuring reduced the capital of Greek banks, the Greek state has to borrow from the Troika in order to recapitalise them, reducing the net benefit of the haircut on the size of national debt.

What prevented the debt restructuring from being implemented in this way?

The government of Lucas Papademos, in which I was running its Economic Office, undertook to implement a plan that had been already adopted. The previous government had agreed on how the PSI would take place. We managed the implementation of the earlier political decisions.   Our problem was re-establishing credibility for the country.  We could not afford going back to square one and waste time on reneging on earlier agreements.  Had we followed that treacherous path, Greece would be out of EMU and perhaps out of EU today. The Papademos government saved the country from a complete collapse, from a catastrophe that would have taken us back 50 years. Papademos single-handedly tried to negotiate the terms of the PSI.  His government negotiated the terms of the new economic programme as well.  That programme became more flexible and acknowledged the possibility of larger negative multipliers originating from the fiscal consolidation.  It also pushed hard and jump-started the stagnating reform effort. The government implemented the PSI in a friendly manner, which was, at an international level, a new innovative process regarding the restructuring of public debt. All legal practitioners in the industry have recognized this and it is considered a major achievement despite the fact that we, as economists, wanted the restructuring to take place in a different way.

Do you think that the recovery programme would yield better results if Papademos’ government had remained in power? In other words, were the extraordinary parliamentary elections in the spring and summer of 2012 a mistake?

Greece lost nearly six months due to the elections, not only because of the elections themselves, but also because of the protracted negotiations with the International Monetary Fund, the European Central Bank and the European Commission on the economic programme and the measures that it would include.  Those protracted negotiations achieved almost zero.   Yes, a 2-year extension was achieved, but this was already incorporated in the EMU the Papademos government had signed. The protracted negotiations released domestic political pressure but delayed the arrival of cash. During this period, the economy was going down and down, with sentiment dipping and fear settling in. If the previous government had continued its activities, the economic downturn would not have been so great and the date of future recovery would be more visible. But this is how politics works.  It was a political decision and there was nothing that could be done about it by the technocrats.

According to Greek media, twenty thousand people will lose their jobs after the consolidation of the banking sector in Greece. Is this figure real?

Nobody can know that number exactly. Indeed, due to the economic downturn and the decline of banking activity, the sector as a whole is likely to shrink. Whether there will be layoffs due to mergers of banks depends on the policy each institution will apply separately.

Currently, the merger of Eurobank and the National Bank of Greece (NBG) is underway. Will such a merger follow for their subsidiary banks in Bulgaria - Post Bank and United Bulgarian Bank?

I'm not the expert who can answer this question. Do not forget, the merger of parent banks will take time.

Why did EFG and Eurobank split this year?

Eurobank was a member of the EFG Group until the summer. At the same time, Greece was a serious risk to any foreign investor. Although the shareholders remain the same (the whole Latsis family), the share capital has been distributed among several family shareholders. In this way, the obligations of the group to the supervisors are different and, more important, while the shareholders remain the same, the developments in the Greek economy cannot affect the corporate group as a whole outside Greece.

Other major foreign investors - mainly French banks such as BNP Paribas, Société Générale and Crédit Agricole withdrew from the Greek banking market. Why did they leave Greece and how will it affect the local financial market?

I think that French banks left because they failed to become profitable while they were in the Greek banking market. I do not know whether it was because they had not sent the right people here to achieve the goals set or because they did not hire the correct local staff who knew the Greek market well. In any case, since the French banks failed to realize profits in the good times of the Greek economy, there is no way for them to manage to do so in this period. For the Greek market, the withdrawal of French banks is insignificant too because while they were here they did not expand to become major players.  After their departure, local banks are getting slightly bigger.

The recapitalization of banks has been postponed and it is expected to take place in April 2013 instead of this autumn. Why is that?

Before banks can be recapitalized, Europeans have to release the funds and for them to release the funds, they required that the three-year programme 2013-2016 were approved by the Greek Parliament. The elections delayed the process.

Will the state have a voting right in the management of banks after their recapitalization?

The Hellenic Financial Stability Fund (HFSF) will hold ordinary shares and it will have the right to vote in strategic decisions that are important to the banks. Since last year, the Troika has been insisting that the State should stay away from the day-to-day management of banks. In such decisions, the public sector is represented by the HFSF. It does not have a voting right when it comes to issues relating to staff management or to decisions on a monthly or quarterly basis. The state will give this freedom to those banks that are able to raise from the market 10% of the funds required to fulfil the capital adequacy criteria. Commissioners approved from the government and the Troika will be appointed to the Board of Directors of each bank to monitor the implementation of the restructuring plans and the use of the State’s and Troika’s funds.

The Troika has set a condition to distinguish between healthy and other banks, assuming that the market will invest in these healthy banks.  They imposed the 10% rule.  The problem with the 10% rule is that banks in the European market are traded at half their book value. This makes it very difficult for new investors to decide to participate in the capital increase of Greek banks because they are likely to lose a significant amount of their investment almost immediately. The problem was discovered in March this year. Investors would, however, be willing to bear the immediate losses after the capital increase, only if they are given sufficient teasers, like cheap warrants to be able to buy back the rest of the stocks later on.

In the end, will banks independent of the state remain in Greece?

The banking sector is a successful example in the modern economic history of Greece and I think it will be able to return to private hands.  After all, Greek bankers are among the best in Europe.  Today, the recapitalization comes from European funds.  Thus for a while, Europeans will keep an eye on the banks.  They have already spelled out that banks cannot easily finance political parties.  The 10% participation rule is supposed to prevent politicians from using banks for their close political/party interests.

Don’t lenders trust the banking supervision in the country, which is to protect the financial institutions from the interference of political interests?

Since Greece has effectively defaulted as a result of the policies pursued over decades, the Troika has no reason to have confidence in the Greek political system. That system can control bank supervisors over the intermediate run.  Bankers are at the same time the favourite kicking cans of politicians.   Hence it all goes back to politics. Greece had a strong banking sector, which has achieved a lot and even moved beyond the Greek border.  The Troika knows this and does not want the same political system that has led to the collapse of the local economy to deal with the banks, directly or indirectly.  European lenders know that in order to save the banks, there should be temporary nationalization, but not one that gives ability to politicians to mingle in the banks. So, the lenders have set conditions to keep politicians away from bank management and bank financing.

What is the outcome of the present situation?

Three-four banks in the country remain healthy. These are the banks represented in Bulgaria, Romania, Turkey and other countries in the region. They have proven that they can cope (before the debt haircut). The final outcome after 3-5 years should be larger, stronger, private banks. 

There is the view that the consolidation of banks could threaten the competitiveness of the financial market in the country, that a banking cartel could be formed, which would not allow transparency and would control interest rates not on the basis of a market principle. What do you think about this statement?

Things are tending towards a banking union in Europe. The eurozone cannot remain as it was before. It will either integrate or disintegrate – an option that nobody wants because it would be too costly to everyone in Europe. A closer integration of the banking sector, of general bank assurance, resolution and supervision is coming too. Economic integration will come, which will probably be late, but it will be implemented by the issuance of some short of Eurobonds and more fiscal coordination. We cannot stay where we were before. This model no longer works.

This new model should not perceive the National Bank of Greece, Alpha Bank, Eurobank or Piraeus as only Greek banks, but as banks of the eurozone. The size of Greek banks compared with the eurozone is quite small. In the case of an economy, that has open borders and where the consumers can take out even a housing loan from a British or a German bank via the Internet, we can talk about competition. When there is a larger integration, competition becomes easier because you're going to compete with more banks, and the market expands. So, I do not think that the restructuring of the Greek financial sector now will make the banking market in the country more oligopolistic.

Market liberalization and public sector reform are the two things in Greece for which laws have been constantly enacted and which are not fully implemented in practice subsequently. Why is that?

In general, the introduction of structural reforms in all economies and countries carries short-term political costs. These reforms directly and immediately (negatively) affect specific groups of people but give results in the long run. It is not true just for Greece but also for other countries. The government has a certain period of time to act. In most cases, making changes that will affect the political clientele is avoided. It is not easy to push measures supporting the common good that trample on the individual interest of someone who has helped you get elected or reach a certain position.

Isn’t this way of thinking a luxury during the bailout agreement?

Yes, it is a luxury, but the Greek political elite did not understand in early 2010 that the period we were entering would bring a huge change to the Greek economy and society, that the familiar past was over. The overwhelming majority of politicians believed that it was another small recession, like the one that the majority of countries had experienced in 2008 and 2009. Bulgaria passed through a similar recession in this period as well, but then recovered. Here, however, things were different.

Few of the participants in the government at the time had realized that it involved changing the entire framework of the Greek economy. In the beginning, they took some fiscal measures to slightly reduce the deficit – they cut wages,  pensions a little, reformed the social security system, began to reorganize the central government, the Ministry of Finance began to control the expenditure of other ministries more closely. There were significant changes in the first four months of the first bailout, between May and October 2010, but subsequently many deep and necessary structural reforms were postponed.

Politicians originally considered some of those reforms as being easy-to-implement.   Yet they were not. The majority of ministers were reluctant to implement the reforms they had voted on. They did not issue the ministerial decrees, which were to repeal the old law and to introduce in practice the changes under the recovery plan. When I entered the Prime Minister’s office in November 2011, I found that only 22% of the laws that the Greek Parliament had voted during the year 2010, were actually fully implemented in November 2011, at least 11 months later.  In other words, many Greek politicians had tricked the supervisory Troika. They voted laws that were not enforced. This is why Greece lost all its credibility, despite the drastic fiscal measures it has taken over the past three years.  Now Europeans ignore the huge pain of the fiscal measures and only look at the failures in fully completing the structural reforms. Greece is going through the most severe fiscal adjustment programme a developed country undertook in the past 50 years.

Regarding structural reforms, no matter how much the Greeks were bound by the lenders to do, they should have done at least double that to begin restoring the economy. Fiscal measures should have followed those structural reforms. Yet, the opposite sequencing took place, first fiscal contraction and then reforms. So the economy is stuck.

Now, the majority of politicians see the problem, but do not have the ability or maturity to articulate a plan on how Greece can move forward. The dialogue about the three-year fiscal plan demonstrated this. No dialogue took place at all in the Greek Parliament. Although the majority of people are ready for the changes, our politicians remain permanently stuck to their past ways and methods. This connection with past habits, and the refusal to think out of the box in order to save the economy and society turns out to be the most conservative policy that is still being pursued in Greece, whether the extreme left or extreme right is following it.  I would dare say the Greeks are currently divided into two camps – those, who want to see the country creating wealth and jobs again and those, who insist that the country should remain in the past and want someone to pay them for that.

What is next for Greece?

We have a double task:  First, to carry the reforms and fix the supply side of the economy and second, to stop the recession, namely avoid the collapse of demand.  The task for Europeans is to provide much needed liquidity.  For Greeks, to implement the deep but necessary structural reforms, which the political system had not realized how important they were back in 2010. At the same time, we should not implement new policies that will continue to reduce market demand and deepen the recession in 2014 and 2015. Negative growth must stop. This is a difficult balance. The political system must put a large number of people to work really hard for the common good, just like Lucas Papademos’ government did with his office people - seven days a week, 16 hours a day.

How do you evaluate the activities of the three-party coalition government so far?

I think that today's government knows perfectly well what needs to be done, something that was not yet fully clear back in 2010. The government’s work will become apparent hereafter. Important steps have been made already. The Prime Minister has shown that he knows very well the problems of the Greek economy. He has undertaken to closely oversee the ministries. He understands the liquidity problems of companies.  He understands he has rebuild credibility for the country. He tries to facilitate private investment. He emphasizes public investment and the absorption of European Union structural funds. The government must also take the opportunity to present to the rest of Europe what Greece has achieved over the past three years in fiscal consolidation, in competitiveness, in structural reforms.  Greece is setting the stage for a healthy recovery.