Financial Word of the Day
Primary Surplus: Tax revenues exceed program spending.
The Story Behind the WOD
Obviously, that’s not an accurate title for every Greek in the world. I just like the Game of Thrones reference. Even though the Lanisters are known for always paying their debts, they have actually incurred a tremendous amount of debt from the Iron Bank while all their sources of income, gold mines, ran dry. The Lanisters and Casterly Rock are similar to Greece. Both were very wealthy and powerful realms but over time their resources dried up and never replaced. Now both are suffering from a “primary deficit.” The Lanisters have used the Iron Throne, and Westeros, as collateral to continue to borrow from the Iron Bank. Eventually, their fate and all of Westeros could be similar to that of Greece. Greece on the other hand does not have similar collateral. Their creditors want Greece to turn a primary surplus and start implementing austerity measures.
Over seven years ago, I was a year out of college when I got my second full-time job at a local investment manager working in the quantitative fixed income group. A year later the Great Recession happened and we all thought we might lose our jobs. That was 2009, the year I got married and the year after I bought my first house. Since 2009, I feel like I’ve been talking about Greece on the brink of default. Six years, later it feels like Groundhog Day because when I looked on StreetEYE yesterday morning, the top article was about Greece and there were about 5 other articles in the top twenty. I was looking for a topic so I’ve decided to talk briefly about why Greece is in the news, what they need to accomplish to avoid default, and what’s the likely hood of this occurring? I’ll try to keep this as basic and painless as possible.
Why is Greece in the News?
For the past few years, Greece has been suffering a credit crisis because they have a primary deficit which means they are spending more than they make. Which in turn makes their credit rating fall and creditors are less likely to lend them money at any rate. Without being able to borrow, they’ll be unable to make payments on their debt and default on their loans. Not many people want this to happen because Greece is a part of the European Union (EU) and nobody is sure what will happen to the Euro, the currency of the European Union, if a country defaults and has to leave the union. There was never a plan to leave, only a plan to get it in. I know it doesn’t make a lot of sense. Basically, Greece needs to cut expenses but the proposed cuts seem unrealistic and the Greeks aren’t eager to implement much in terms of austerity.
What does Greece need to accomplish to avoid default?
To make Greece more appealing to creditors their European partners came to an agreement with Greece on a plan to make them more credit worthy. The plan consisted on primary surplus targets and reforms to help Greece achieve those targets. That agreement occurred in 2012 and Greece is nowhere near achieving those targets. Now, Greece is arguing that those targets our unrealistic given current economic circumstances in the country and that a new plan needs to be created to help Greece through this new rough patch.
Greece wants the primary surplus targets lowered, but what would a reduced primary surplus target mean for Greece?
- Less fiscal and economic adjustment for Greece.
- More external financing and debt relief that may not be realistic.
Recently, the Greek government offered a new plan.
- Lower primary surplus targets from 4.5% of GDP to 3.5%
- Two more years to hit targets
- This year’s target will be 1%
- Limited set of reforms
The article from International Monetary Fund’s global economy forum states two conditions that need to happen for Greece’s plan to be effective.
- Greece needs to offer credible measures to meet targets which cannot be obtained without reform to the value-added tax(VAT) to widen it’s base, and pension reforms. Pension expenses account for 16% of Greece’s GDP.
- European creditors need to agree to additional financing and debt relief which would be enough to maintain debt sustainability.
What’s the likely hood of this plan occurring?
It’s going to be a tough process and sadly for all of us, this won’t be the last time we’ll hear about Greece’s woes. Instead of actually fixing the problem. I think, like most of the major issues we’re facing, they will simply place a last second band-aid on the issue that will need to be ripped off in the coming in the future.