1. KBank Capital Market Perspectives Market Updates
Macro / FX / Rates
Why should Germany and France save Greece?
22 July 2011
Euro-area leaders recently annouced that the eurozone and the IMF
would provide additional EUR 159bn (USD 229bn) to Greece Amonthep Chawla, Ph.D. -
Greece is seen to benefit more from staying in the eurozone than Kasikornbank
amonthep.c@kasikornbank.com
leaving it
Germany and France are likely to protect their interest by keeping
Greece inside the eurozone so as to reduce financial volatility
Thai economy will need to prepare for another round of economic
turmoil because the recent negotiation will last only temporarily
while the fundamental problems are not yet resolved.
Disclaimer: This report
must be read with the
Disclaimer on page 7
that forms part of it
Some doctors save a life of a patient by cutting off his leg
Debt crisis in the eurozone has been spreading from Greece to Ireland and Portugal.
These three countries requested financial aid from the IMF and the ECB in exchange of
their fiscal reform, which could guarantee that they could pay back loans and service their
bond interest payments. However, sluggish tax increase and spending cut has led to
series of bail-out, which deteriorate the credibility of the eurozone. Euro-area leaders
recently annouced that the eurozone and the IMF would provide additional EUR
159bn (USD 229bn) to Greece. The region is likely to increase rescue fund to other
countries that have trouble servicing their debt as well. Greece is going into “selective
default”, which includes a voluntary extension of the bond maturity and lower the bond
yields. Investors will need to accept haircut. Enormous debt in Spain and Italy triggered
the market to question the sustainability of the region. Why can’t the core countries, i.e.
Germany and France, just get rid of some bad apples before they ruin the whole basket?
Is it possible to kick Greece out of the eurozone?
Fig 1. Budget deficit to GDP Fig 2. Current account balance to GDP
% GDP % GDP
5 10
5
0
0
-5
-5
-10
-10
-15
-15
-20 -20
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Germany Greece Italy Spain US Germany Greece Italy Spain US
Source: Bloomberg, KBank Source: Bloomberg, KBank
Just like any other political or economic settings, the eurozone started with hope that it
will reduce price volatility, subside social instability and promote economic prosperity. As
time goes by, the eurozone is being challenged by global economic crisis as well as fiscal
solvency. It has been originally formed to coordinate regional monetary policy so as every
country uses common interest rate and currency. Meanwhile, each country maintains
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2. independence of fiscal policy. In order to avoid inconsistency between these two policies,
the eurozone members promised, as stated in the Lisbon Treaty, that they would
maintain fiscal discipline in their countries, i.e. keeping fiscal deficit under 3% of GDP and
public debt below 60% of GDP. However, significant number of members are not able to
keep their promise that they gave before joining the eurozone. There are some rules to
punish countries that do follow fiscal discipline, yet there is no rule stating that these
countries could be expelled from the group. It is understandable that they would not draft
any plan to break up the eurozone; similarly there is no part in the US constitution on the
procedure to break up the United States. On the other hand, it is possible for any country
to voluntarily withdraw from the eurozone. That means Greece could simply leave the
currency union, start its weaker national currency to gain competitiveness and solve its
economic crisis. However, Greece decided to stay regardless of several political
demonstration against the austerity measures. Meanwhile, Germany and France are
seen to try very hard to keep Greece inside the eurozone. What do Greece, France and
Germany mutually benefit from the eurozone?
Fig 3. Twin deficits Fig 4. Debt to GDP
% GDP % GDP
180
US
160
Spain 140
120
Portugal 100
Italy 80
60
Ireland 40
20
Greece
0
-35 -30 -25 -20 -15 -10 -5 0 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16
Germany Greece Ireland
Current account deficit Budget deficit Italy Portugal Spain
Source: Bloomberg, KBank Source: Bloomberg, KBank
High cost of staying
Could Greece recover from its ailing economy by leaving the eurozone? Greece lost
control of its monetary policy after it joined the eurozone in 2001. Consequently, Greece
has been using the interest rate set by the ECB to control regional price volatility, yet it is
not dependent on Greece’s labor market condition. Higher interest rate is likely to deter
labor market recovery, leading to higher unemployment rate, poverty and recession.
Further, Greece has adopted the euro as its national currency, preventing it from
changing the exchange rate to rebalance the current account deficit. Greece’s poor
export performance could have been improved by allowing the exchange rate to be
weaker against neighboring countries so as to gain competitiveness. At the same time,
Greece has to cut budget deficit and lower public debt. Greece has recently passed the
austerity measures to raise taxes and cut spendings. The plan is seen to slowly create
fiscal strength to the Greek government in expense of its citizens. Some public
employees will lose their jobs. Salaries, pensions and other public benefits will be cut.
Domestic consumption will subsequently fall, leading to an economic recession.
Privatization of state enterprises will be implemented to reduce fiscal pressure and to
gain enough capital to pay off debt, which will reduce national assets and increase
dependency on foreign companies.
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3. Fig 5. Greece’s export by product 2010 Fig 6. Percent of world export
% world export
Food
6
Manufactured Goods 23%
and Articles 5
33%
4
Crude Materials ex cl
3
Fuels 2
7%
Greece's ex port by product 2010
1
Mineral Fuels
9%
0
Machinery and
1990 1994 1998 2002 2006 2010
Transport Equipment Chemicals
13% 15% Portugal Ireland Italy Greece Spain
Source: CEIC, KBank Source: World Trade Organization, KBank
From the point of view of taxpayers in France and Germany, the bail-out plans are seen
to incur losses to them, either by extending bond maturity or shifting financial burden to
investors. Costs of rescuing Greece and other indebted nations will surge, which will
trigger demonstration in the lending countries. It is likely that Greece cannot reform its
fiscal stance, then taxpayers in Germany and France could stop their government from
bailing out Greece, or even could threaten these founding countries to leave the
eurozone.
Fig 7. Current account Fig 8. Number of Visitors
16,000 0 Millions
14,000 18
-10,000 16
12,000
14
-20,000
10,000 12
8,000 -30,000 10
6,000 8
-40,000 6
4,000
-50,000 4
2,000 2
0 -60,000 0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010
Current Account: Serv ices: Trav el (left, USD mn) Current Account (right, USD mn) Visitor Arriv als: Europe Visitor Arriv als: non-Europe
Source: CEIC, KBank Source: CEIC, KBank
Higher cost of exiting
Let’s say Greece wants to leave the eurozone, abandon the euro and revive its drachma.
Is it going to benefit Greece? For sure, Greece could gain control of its monetary policy.
Greece’s central bank could set a policy rate that is in line with its macroeconomic
conditions so as to promote employment and lower price fluctuation. Greece could set its
drachma weaker than the euro in order to gain competitiveness in exports, which will
solve its long-lasting current account deficits. Main sources of foreign income are
tourism and exports of food and vegetable product. Increase in exports and the
number of tourists from Europe will favor Greece’s economy. However, the cost of
exiting the euro could be excruciating to its economy.
First, Greece will have to re-denominate its existing euro to the national currency, which
will inevitably encounter technical difficulties. For example, banks will need to re-
denominate mortgage loans, credit card debt, bank deposit in all electronic system into
the national currency. The government will need to pass a law to re-denominate taxes,
government employees’ salary, public pension and other measurement as well. Second,
Greece will need to prevent capital flight after depositors or investors anticipate that
Greece will re-denominate their claims from the euro to the national currency. The
change to national currency is likely to reduce their asset values, which will rush people
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4. to take money out of Greece to other eurozone countries and lead to bank run or collapse
in Greece’s financial system. Third, financial uncertainty will lead to another round of
credit-rating downgrade, which will result in greater sovereign spreads and higher interest
costs. Higher interest costs and weakening national currency will increase the amounted
of debt, which is originally denominated in the euro. Despite gains in export
competitiveness and increase in employment, higher inflation from weakening currency
could outweigh gains in higher wage, leading to lower real income of Greek people.
Greece could implement capital control temporarily to force its citizen and investors to
surrender their euro to the new national currency. However, such policy will greater
isolate Greece economically from the region.
Why Germany and France need to help Greece? Greece’s economy is relatively small in
the eurozone. However, Germany and France are heavily exposed to Greece’s debt.
Failure to pay off debt and continual decline in the bond market prices could severely
affect the financial sector in the lending countries. Therefore, it is an act of self-interest for
Germany and France to save Greece and prevent this contagious effect to spread to
other borrowing countries.
Fig 9. Percentage of gold in foreign reserve Fig 10. Exposure of Greece’s debt by other countries
USD bn
% 60
90 383
112
80 8,134 50
3,401 2,452
70 2,435
40
60
50 30
228
40 20
30
20 10
10 109 1,054 0
0
Spain Japan Belgium Sw itzerland Italy US UK Germany France
Portugal Greece USA Germany Italy France Spain Thailand China
% of reserv es Public sector Banks&priv ate lending
Note: the numbers above the bar graph indicate tonnes of gold Source: BIS Quarterly Review June 2011, KBank
Source: World Gold Council, KBank
What’s next for Greece and the eurozone?
The latest attempt to bail out Greece and perhaps other indebted nations are likely to be
just a short-term scheme to gain confidence back to the eurozone. Greece may have
received money to pay off debt; however, it needs to generate new money to finance
interest payment as well as the principal of the debt. How can Greece generate new
money? One thing for sure is to extract income from its citizen by raising taxes and
cutting spending so as to generate budget surplus. One major difficulty is that tax
revenue will be unavoidably lower after Greece’s economy is going toward recession.
People will have lower income. Consumption will decline. Subsequently, taxes levied on
income and consumption will fall. What about privatization? Yes, Greece can earn a great
deal of revenue by selling off national property to foreign investors. However, Greece will
need to bear the consequence that it is likely to pay higher price for using the state
utilities. How about selling gold? Greece’s central bank holds a great deal of gold over
112 tonnes, or nearly USD 6bn. Greece could easily service its debt payment. What has
restrained Greece from not selling off gold? One reason is that the IMF has set a
regulation to prevent a country’s central bank to sell gold, which could intervene the gold
prices in the market. However, Greece could sell gold directly to the IMF for certain
amount. What if Greece increases its exports and boost tourism? Sure, it does sound like
a great idea, but how? Greece cannot simply lower price of its export products because
its currency is fixed by the euro. Export of food product is seen favorable as it relies less
on import of oil, capital goods and intermediary products. Food export is accounted for
about 20% of total export, yet it is unlikely to generate enough revenue.
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5. In the short-run, Greece is unlikely to acquire enough money to pay off debt. Should
Greece ask for another round of bail out? Or should investors just accept haircut and
banks start to increase their capital to rebalance their balance sheet? Debt crisis in the
eurozone is likely to come back to haunt investors again in the near future. Apart from
Greece, the eurozone is full of indebted countries, which are unlikely to meet the target of
fiscal discipline set by the region. The problems of regional insolvency is likely to grow
bigger when big economies, such as Spain and Italy, annouce default. Thai economy
will need to prepare for another round of economic turmoil because the recent
negotiation will last only temporarily while the fundamental problems are not yet
resolved. The amount of international trade between Thailand and Greece or other
eurozone countries are small. However, volatility in exchange rate will affect
capital flows, which will subsequently result in an increase in the volatility of Thai
baht.
So what could be a long-term solution? One possibility is to plan for an exit strategy for
countries that could no longer integrate in the region. An exit strategy should prevent both
the exiting members and the existing members from economic crisis. Countries may be
allowed to temporarily adopt the euro as their national currency in order to insulate price
volatility during the transition until they pay off their foreign debt or regain strength to
overcome economic difficulties. Apart from looking a way to break up the eurozone,
countries in the eurozone could increase integration in fiscal policy and political
indentities so as to increase power of the central planner to solve the regional economic
problems. This could be an ideal solution to reduce diversity of the region in terms of
economic development and fiscal policy. We could experience the revival of the Roman
Empire or the European version of the United States. In such case, price volatility will
reduce, which will greater increase economic growth and international trade. Thai
economy is likely to benefit from the global economic stability as fund flows and
exchange rate will be less volatile.
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6. Table 1. Monthly Key Economic Indicators Nov 10 Dec 10 Jan-11 Feb-11 Mar 11 Apr 11 May 11 Jun-11
Manufacturing index (ISIC) 189.1 189.6 189.5 188.2 186.7 180.1 181.3
% YoY 5.7 -3.4 4.1 -3.0 -6.7 -8.1 -3.9
Industrial capacity utilization rate (%) (ISIC) 63.6 62.4 62.3 59.5 66.1 54.4 58.7
Retail sales (% YoY) 8.3 8.4 9.6 9.0 4.1 7.9 n.a.
Total vehicle sales (units) 78,874 93,122 68,398 77,213 93,008 67,283 55,851
Motorcycle sales (units) 152,767 167,707 165,152 188,248 191,437 174,244 163,411
Unemployed labor force ('000 persons) 389 268 268 374 268 276 n.a.
Unemployment rate (%) 1.0 0.7 0.7 1.0 0.7 0.7 n.a.
Consumer prices (% YoY) 2.80 3.00 3.03 2.87 3.14 4.04 4.19 4.06
core 1.10 1.40 1.32 1.45 1.62 2.07 2.48 2.55
Producer prices (% YoY) 7.1 4.7 6.0 7.4 5.9 6.6 6.2 4.5
External Accounts (USD mn, unless specified otherwise)
Exports 17,584.0 17,220.0 16,523.0 18,406.0 21,072.0 17,243.0 19,284.0
% YoY 28.7 18.6 21.4 29.1 31.0 24.7 17.3
Imports 17,094.0 15,911.0 17,111.0 16,375.0 19,180.0 17,720.0 19,010.0
% YoY 35.0 8.8 31.2 18.6 27.2 26.3 34.4
Trade balance 490.0 1,309.0 -588.0 2,031.0 1,892.0 -477.0 274.0
Tourist arrivals ('000) 1,500 1,840 1,810 1,822 1,765 1,506 1,376
% YoY 10.3 9.5 12.8 12.8 22.7 35.9 68.8
Current account balance 1,019.0 1,750.0 1,090.0 3,823.0 1,881.0 -165.0 -511.0
Balance of payments 820 2,263 1,689 4,271 1,365 3,570 -2,600
FX reserves (USD bn) 168.2 172.1 174.0 179.2 181.5 189.9 186.2
Forward position (USD bn) 15.3 19.6 19.0 17.7 20.8 21.4 23.5
Monetary conditions (THB bn, unless specified otherwise)
M1 1,235.4 1,302.4 1,326.2 1,346.4 1,345.6 1,347.6 1,396.4
% YoY 10.8 10.9 15.5 13.4 13.8 14.0 10.7
M2 11,497.6 11,776.4 11,817.2 12,152.9 12,280.3 12,481.0 12,563.0
% YoY 11.1 10.9 11.5 13.7 13.1 15.2 14.2
Bank deposits 10,387.9 10,584.9 10,606.3 10,834.2 10,891.3 10,966.1 11,084.4
% YoY 8.1 8.7 8.8 10.3 9.0 9.9 8.4
Bank loans 9,751.1 9,947.0 10,064.5 10,209.7 10,308.2 10,376.2 10,516.8
% YoY 12.3 12.6 14.5 15.1 14.9 15.3 15.6
Interest rates (% month end)
BOT 1 day repo (target) 1.75 2.00 2.25 2.25 2.50 2.75 2.75 3.00
Average large banks' minimum lending rate 6.00 6.12 6.37 6.37 6.62 6.75 6.75 6.87
Average large banks' 1 year deposit rate 1.11 1.32 1.51 1.51 1.67 1.86 1.86 2.03
Govt bond yield 1yr 2.11 2.38 2.54 2.68 2.83 3.00 3.15 3.50
Govt bond yield 5yr 2.98 3.26 3.40 3.48 3.41 3.38 3.50 3.78
Govt bond yield 10yr 3.59 3.77 3.85 3.89 3.75 3.70 3.79 3.91
Key FX (month end)
DXY US dollar index 81.20 79.03 77.74 76.89 75.86 72.93 74.64 74.30
USD/THB 30.21 30.06 30.93 30.60 30.28 29.88 30.32 30.73
JPY/THB 36.11 37.01 37.60 37.47 36.42 36.80 37.17 38.13
EUR/THB 39.22 40.23 42.35 42.25 42.86 44.24 43.64 44.56
Source: Bloomberg
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7. Disclaimer
For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or
sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we
believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained
herein. Further information on the securities referred to herein may be obtained upon request.
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