Komal Sri-Kumar
Senior Fellow; President, Sri-Kumar Global Strategies
Asia and California and Capital Markets and Europe and Finance and Global Economy and Public Policy and U.S. Economy
Dr. Komal Sri-Kumar is president of Santa Monica-based Sri-Kumar Global Strategies, Inc., a macroeconomic consulting firm that advises multinational firms and sovereign wealth funds on global risk and opportunities.
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Greece: ItaEUR(TM)s too soon to exhale
By: Komal Sri-Kumar
June 18, 2012
In parliamentary elections closely watched for their implications for the Eurozone, the center-right New Democracy party eked out a small margin of victory over Syriza, a coalition of the far-left. With almost all votes counted, ND garnered 29.7% of the vote, compared with SyrizaaEUR(TM)s 26.9%. The winning party also gets a 50-seat bonus according to Greek law, giving it 129 seats in the 300-seat parliament. Syriza will hold 71 seats. The close election, and the lack of official polls for the past two weeks in accordance with regulations, had kept global markets on edge. The focus on the results in Greece also pushed to the background yesterdayaEUR(TM)s legislative victory for FranceaEUR(TM)s Socialist party which followed FranA?ois HollandeaEUR(TM)s win in presidential elections on May 6. President HollandeaEUR(TM)s partyaEUR(TM)s success yesterday will give him additional ammunition to push his agenda involving increased fiscal spending and higher taxes on the wealthy.

ND leader Antonis Samaras supports Greece staying in the Eurozone, but has promised to tweak austerity conditions under which the government receives bailout funds from the European Union, the European Central Bank and the International Monetary Fund (the aEURoetroikaaEUR?). By contrast, Syriza leader Alexis Tsipras would unilaterally aEURoetear up the memorandumaEUR? containing the bailout conditions. Mr. Tsipras would also like to keep Greece in the Eurozone, but bets that frightened European leaders aEUR" headed by German Chancellor Angela Merkel aEUR" would be forced to offer Greece easier terms for the loans since a Greek exit from the Eurozone would impose large losses on the European banking system.

Mr. Samaras will try to form coalition government

Since no party won a majority of seats, the next government to be headed by NDaEUR(TM)s Mr. Samaras may include the centerleft party, Pasok, and the Democratic Left party which came in fourth after ND, Syriza and Pasok. ND and Pasok, in particular, have had widely different agendas in the past and have been bitter political rivals, and it is doubtful they would be able to implement a consistent set of measures, especially during a period of intense economic and social tension. And despite statements by senior German leaders that they would support some relaxation of conditions if Syriza did not win, the incoming Greek administration will have little political leeway to impose any more austerity in the fifth consecutive year of recession. I estimate that real GDP will decline by a further 5-7% in 2012.

Syriza appears to have chosen the high ground by refusing to form part of the new government. Conceding defeat last night, Mr. Tsipras reiterated that canceling austerity conditions was the only viable solution and aEURoefrom Monday we will resume the struggle against it.aEUR? Despite its failure to come out on top in yesterdayaEUR(TM)s elections, SyrizaaEUR(TM)s opposition to further belt-tightening is a popular stance. For example, the troika requires Greece to lower the primary budget deficit by a,?11.5 billion aEUR" the equivalent of about 5% of GDP aEUR" over the next couple of years through tax increases and spending cuts despite the continuing recession. If such measures lead to more riots as has been the case in the past couple of years, Mr. TsiprasaEUR(TM)s popularity will probably increase.


The failure of Syriza to form a government resulted in the Greek 10-year bond yield declining only to 25.1% this morning from 25.6% at FridayaEUR(TM)s close, suggesting that the euphoria over the election results may be short-lived. Even if the troika allows the flow of funds sufficient for Greece to make payments to creditors, the new administration will lack the resources to make pension and wage payments. The government is already several months in arrears in paying workers and suppliers. The Greek tragedy of the unending sequence of bailouts, failure to meet economic stabilization conditions, and rising public opposition to austerity, is likely to persist, putting pressure on Greek and global financial markets.

Spain and Italy: Pressure Persists

With Greece maintaining its potential for contagion, EuropeaEUR(TM)s problems came even closer to Spain and Italy last week. In other words, while the initial spark for the forest fire came from Greece, the fire has since spread to the fourth and third largest Eurozone economies, and may continue even if the initial fire is put out.


Despite Spanish Prime Minister Mariano RajoyaEUR(TM)s claim last week that a a,?100 billion infusion of cash by the EU in the Spanish banking system would help recapitalize Spanish banks without adding to the governmentaEUR(TM)s debt burden, markets focused on the fact that the new funds would, indeed, boost SpainaEUR(TM)s public debt aEUR" GDP ratio by as much as 15 percentage points. Compared with about 67% at the end of 2011, the bailout, when completed, would push the ratio to over 80%. Consequently, markets viewed Spanish country risk as having risen rather than fallen as a result of the bank recapitalization plan.

A three-notch downgrade last week by MoodyaEUR(TM)s rating agency of Spanish credit put further pressure on Spanish ten-year debt yields which hit, but backed off from, the 7% level. This morning, the Spanish yield has risen further to 7.03%. None of the European countries which have received bailouts aEUR" Greece, Ireland or Portugal aEUR" has been able to return to private capital markets after the ten-year sovereign debt yield hit the 7%-mark. And while Italian yields have been lower than Spanish yields in recent weeks, they have closely followed movements in Spain as investors fear that Italy could be next in the line of countries requiring a bailout. ItalyaEUR(TM)s ten-year debt yield rose today by 12 basis points to 6.02%. Italy, with a,?1.9 trillion in total public debt aEUR" the equivalent of 120% of GDP aEUR" is simply too big to bail out, and will force European authorities to try radically new measures to end the regional crisis.

A crucial weakness of the European financial system aEUR" and a key factor in the contagion aEUR" is that depositors in banks located in countries under threat are simply not being compensated for the risk of exchange and capital controls. As Spanish or Italian depositors move portions of their savings to banks in Frankfurt without incurring an exchange rate risk, or to Zurich or London in order to avoid the Eurozone altogether, the pressure on Spanish and Italian banking systems will increase. In turn, that would likely prompt additional capital flight. That is the vicious cycle in which the Eurozone finds itself today.

Komal S. Sri-Kumar, a senior fellow at the Milken Institute, is chief global strategist at TCW.