Greece In An Inescapable Debt Trap

by: Disruptive Investor

The recent Angela Merkel visit to Greece might underscore the commitment of eurozone policymakers to ensure that Greece is very much a part of the eurozone. Greece is also expected to receive EUR130 billion in aid. Without this, the government might go bankrupt by November. The focus of this article is on the reasons why Greece might never be able to pay their already gigantic debt and the government will ultimately default and exit the eurozone.

Before I discuss the current and expected sovereign debt scenario in Greece, I would like to focus on the expected economic scenario in the country. Needless to say, the debt increment or reduction will largely depend on how the economy performs in the medium to long-term. I personally expect all austerity measures to be postponed if the economic scenario does remain poor.

According to the October 2012 world economic outlook report by the IMF, real GDP growth in Greece is expected to remain negative in 2012 and 2013 with positive GDP growth probable only in 2015. During the same period, unemployment will remain at elevated levels and might fall below 20% only in 2016. The output gap estimate for 2012 and 2013 is also dismal at negative 6.7% and 9.0% respectively.

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I must add here that the IMF estimates have always been relatively optimistic and I would not be surprised if Greece remains in recession for longer than 2015. However, once this is clear, weak economic growth and high level of unemployment will remain for a prolonged period. Under these circumstances, there is no case for austerity. Civil unrest has already been in the news and if further austerity measures are implemented, the chaos might get bigger.

Another challenge for policymakers will be the factors that will spur economic growth. The gross capital formation is expected to remain well below its peak during the period 2012-17. Further, the real GDP per working-age (15-64) person in Greece is the worst among the eurozone countries.

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Even if investments are above the levels expected, the question of competitiveness remains and has not been addressed by policymakers. The focus of policymakers has just been to save Greece from default and remain committed towards the Euro union. The larger issue of loss of competitiveness among several eurozone countries has not been addressed.

I have my doubts on meaningful improvement in GDP growth and unemployment levels unless these issues are addressed. I can say with some conviction that real GDP growth in Greece might remain muted beyond 2015. In line with this expectation, I don't see an improvement in government debt levels in Greece as expected by the IMF. The IMF expects government debt in Greece to peak at 182% in 2013 and decline to 153% by 2017. On the contrary, I expect debt in Greece to touch 200% of GDP over the next few years. I must also mention here that it would not be a big surprise if Greece exits the eurozone in the next 2-3 years, or even earlier. Therefore, the commitment by Greece to reduce its government debt to 120% of GDP by 2020 looks completely unrealistic.

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Another major issue and fear is the probability of the crisis shifting from the periphery to the core. The contribution to real GDP from core eurozone economies has already dwindled amidst a recession in the eurozone. If the current recession is prolonged, the core economy's government debt might also surge along with a rise in peripheral economy debt. Further, in such a scenario, the commitment of policymakers in Germany to ensure that the eurozone sustains might also dwindle.

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The unfunded liabilities will add to the concern about the swelling debt and the possibility of government debt declining in the future. The NPV (2010-50) of healthcare spending change for Greece is currently at 107% of GDP. Also, the NPV of pension spending change (2010-50) is at 21% of GDP.

Therefore, I only see elements which will increase the government debt over the next decade or further. It is difficult to make a case for lowering government debt in Greece. With bond spreads having surged over 3000bps at one point of time, Greece has already defaulted on its debt. In the foreseeable future, I see the debt in Greece swelling and the country eventually exiting the eurozone.

From an investment perspective, the Euro might be a terrible long-term currency option. I am personally bearish on the Dollar. However, compared to the Euro, the dollar looks better. Also, the banking system in the eurozone is something investors should complete avoid. Greece is surely in the inescapable debt trap and it is just a matter of time before we know the way Greece defaults on its debt repayment obligations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.