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Agreement on Greece - a historic day for Europe!

Blog by Bo Bejstrup Christensen, Chief Analyst at Danske Invest

The media are buzzing with stories about the weekend's agreement between Greece and its creditors. The big risk now is naturally its implementation –can the Greek Prime Minister, Alexis Tsipras, get the creditors' terms passed by the Greek Parliament?

Only time will tell, but we still believe that a final solution will entail that Greece will continue to be part of the euro. But this is not our subject here, since instead we wish to paint the wider picture, in order to understand the Greek agreement, and its significance for the future.

First, we need to go back to 2004, when the Greek government at that time basically admitted that Greek lied about the size of its public deficit, in order to fulfil the convergence requirements.
Again in 2009 and 2010, it emerged that Greece's public deficit was much larger than so far assumed, and in fact twice as large! According to the data known today, Greece thus had a budget deficit of 15 per cent of GDP in 2009. After deduction of interest expenses, the deficit was approximately 10 per cent.

Even then, the public debt was equivalent to around 130 per cent of GDP, and was increasing strongly, in view of the size of the current account deficit. In other words, Greece's public sector and its economy were on an untenable course, and the country was in for some tough times ahead, whatever happened.

Saved too much too quickly
Much has been written about how severely Greece has been treated. We generally agree that – especially with the benefit of hindsight – Greece was asked to save too much too quickly. This should be seen in the light of the consensus at that time on how similar situations had been handled (the experience from Latin America and Asia in the 1980s and 1990s is important here), as well as how Greece was affected by a series of other shocks. We can cite the financial crisis in particular, which, at a critical point in time, crippled the Greek banking system and its lending ability. The banks should have been ready to support the private sector, which could thus have picked up the baton in some of the areas from which the Greek state was withdrawing, in attempts to save money.

During the process, time and time again Greece has failed to implement key reforms, such as establishing an independent tax authority and an independent national statistics agency. Not to mention reforms of a pension system that – given Greece's demographic structure – is quite simply not tenable.

Greek economy grew in 2014
Despite all the mistakes that were made, last year the Greek economy began to grow again. The primary government deficit (before interest expenses which, despite the high debt, are exceptionally low, due to the favourable debt terms) was positive. In brief terms, Greece could have been back on is own feet within a short period, and its elected politicians could have made their own political choices and decisions.

Instead, Tsipras' government came to power on a platform of demands for lower savings, debt reduction and fewer reforms. During the first six months of the year, this government managed to wipe out any remaining confidence among investors and European politicians. This culminated in Chancellor Merkel's historic words: "The most important currency – trust – has gone".

We have never doubted Europe's willingness to help its weakest members, and thus never doubted its willingness to make loans to Greece. To put it bluntly, its willingness to help the Greek people. But naturally, creditors cannot continue to lend out their taxpayers' money to a country that is unable to function with the help of its own (deficient) institutions and dubious political leadership. In brief – last night's agreement is not about money, but about creating a modern Greek state!

This means that the "new" list of reforms includes the requirement to ensure the "independence" of the Greek statistics agency, to "depoliticise the Greek state administration" and to ensure the viability of the pension system.

Too early for debt reduction
One key element is missing: Direct debt reduction. Why? In our view because this is quite simply one of the few means creditors can use to ensure that the reforms actually take place. We believe that most reasonable people should be aware that Greece cannot meet all of its debt commitments in the future. So we are in no doubt either that, in time, some of the Greek debt will be written off – but not until the Greek state has undergone adequate reforms.

The agreement naturally raises a number of political questions – is the EU intervening too far in the affairs of the national state? Many will believe that it is – but here we are just trying to explain why Greece has ended up like this, concluding with this open question – who has been worst for the Greek people? The European or Greek politicians?

What will happen now? The coming days and weeks will be full of political news that will affect the markets. We certainly have not got to the finishing line yet, but we believe we are on the final lap.

On 20 July, Greece must make payments to the European Central Bank. The ECB has already bent virtually all the rules to keep the Greek banking system alive. But if Greece does not pay on 20 July, there will probably be no way out. The ECB will have to switch off the life support system! So we expect that the political process will be resolved very soon.

Several winners
What does this mean for us as investors? European Commission President Jean-Claude Juncker concluded his press conference on Monday morning with the following response to the question of whether the EU has achieved a coup against the Greek government – in view of all the reform demands: "In this compromise, there are no winners and no losers. I don't think the Greek people have been humiliated, nor that the other Europeans have lost face. It is a typical European arrangement."

In our view, this weekend will be inscribed in the history books as yet another severe test in which Europe proved that there is strong unity, that challenges can be overcome through discussion and that respect for the continent's countless conflicts in recent centuries is intact.

Yet there are winners. If we can soon put the Greek crisis behind us, we will not have inflicted too much damage on the European economy. First of all, the European banking system got through the crisis safely. This emphasises how the region now has more robust institutions, and can thereby better weather the inevitable crises that will arise in the future.

Right now, this means that economic growth in Europe is intact. We expect 2-per-cent GDP growth in the Eurozone in the second half-year and into 2016, which is good news for European share investors!
 

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