Guest article written for AllAboutAlpha.com – the official publication of the Chartered Alternative Investment Analyst (CAIA) Association
Originally posted at: http://allaboutalpha.com/blog/2012/08/15/the-greek-opportunity/
“Of all the economic horror stories produced since the banking crisis…” wrote the Guardian in July 2011, “Greece must be the most frightening. It has easily the worst economy out of all the 16 nations in the eurozone…” Such rhetoric about the Greek economy has been commonplace in the last couple of years with journalists and commentators treating the nation (at least in words) as a pseudo-failed state.
Before we begin, let’s be absolutely clear. Greece does have an economic crisis. This is a country which has experienced years of recession, a 20% decline in GDP, huge unemployment and a fair amount of civil unrest (in the form of regular, and sometimes violent, protests). A storm of factors brought Greece to this point. Firstly the spread of the financial crisis to Europe, secondly a political system (filled with corruption, bribery, populism) which was unwilling to reform, and thirdly- some poor fiscal planning. Greece’s key sectors (including tourism and shipping) were also unusually (and perhaps uniquely) vulnerable left-tail economic events.
Let’s also be clear that these are not just Greek problems, the entire Euro Zone sits weakened as the result of a crisis which exacerbated fractures which were already there. Countries like Greece, Portugal, Italy, Spain and Ireland were the most vulnerable within this group- and thanks to the political disconnect of the ‘union‘… were the first to come unstuck.
In sharp contrast to genuine failed (or failing) states such as Afghanistan, Iraq and Nigeria (and also states experiencing extreme volatility such as Kenya, Pakistan and Egypt), Greece sits as nation which, while experiencing a crisis of credibility, has a number of very positive opportunities for recovery, development and wealth creation. So what is the case to invest in Greece?
To learn more, I spoke to Nicholas Economides – Professor of Economics at the NYU Stern School of Business.
Prof. Economides has published more than 100 articles in top academic journals. He holds a Ph.D. and M.A. in Economics from the University of California at Berkeley, as well as a B.Sc. (First Class Honors) in Mathematical Economics from the London School of Economics. Previously, he taught at Columbia University (1981-1988) and at Stanford University (1988-1990). His website on the Economics of Networks has been ranked as one of the top four economics sites worldwide by The Economist magazine. He is advisor to the US Federal Trade Commission, the governments of Greece, Ireland, New Zealand and Portugal, the Attorney General of New York State, a number of the Federal Reserve Banks, the Bank of Greece and major Financial Exchanges.
Q: What needs to be done to ‘fix’ the Greek economy?
[Prof. Nicholas Economides] Fortunately for Greece, there is a stable government with three coalition parties and a significant majority in parliament. Greece must however take some decisive steps in the right direction. There has been some evidence that they’re doing this in context of privatisations and the collection of taxes. I would like to also see further decisive actions aimed at reducing the size of the public sector. Essentially therefore you have a three-pronged approach. Firstly privatisation, secondly cutting the size of the state and thirdly- collecting existing taxes (rather than imposing any new ones).
For some time, investors have been waiting to see decisive actions being taken by the government. As soon as such actions are taken, I think a lot of entrepreneurs will see Greece as being the right place to invest. The three items I mentioned before are very ‘top-level’ and will persuade investors that the government is taking the right actions for Greece.
On the micro level. There is a lot of bureaucracy involved in setting-up or expanding a business in Greece. The government has to work hard on that. It’s not an easy issue as bureaucracy is a ‘many headed monster‘. They have to look at co-ordinated methods by which central and municipal governments can ensure they do not impose hurdles on economic activity. The important thing which central government can do is to promise, without reservation, that there will be no new taxation and ’emergency’ taxation- and that they will focus on collecting existing taxes by expanding the tax-base to those who are evading taxes.
There is a significant part of the Greek economy- maybe 30-40%- is not in the ‘official‘ books. That has to be reined in. To put this in context, if that is reined in… to a large extent, the revenue side of the Greek problem would be fixed. Even if it’s reined in by 50%, it would be a very significant increase in revenue for the government and the state. That has to be a significant goal- to find the tax evaders, rather than imposing more taxes on people who have always been loyal and paid them without question.
Q: What are the strongest sectors in the Greek economy, and do they present opportunities for the future?
[Prof. Nicholas Economides] One strong sector is tourism. Although there are hundreds and thousands of different tourist enterprises in Greece, there are still opportunities for more. There are extremely beautiful areas which are in need of regeneration and there are tremendous possibilities for extra cruise ships to visit the country and islands.
Another sector where things can be improved is shipping. Most of the shipping activities in Greece occur on the ‘high seas‘. A lot of the critical functions of the shipping industry (brokerage, insurance and so on) happen in the Port of Athens. Even though this industry is largely excluded from the Gross National Product of Greece (as the money is typically made on the high seas) it is economically very significant. There are tens of thousands of people in Greece who are employed and supported by the shipping industry.
Specialist agriculture… things that have to do with organic production- without pesticides. This is another area where we have already seen investment activity- it’s something that can be very profitable in Greece.
I should also mention the renewable energy sector. Specifically in this context- wind or solar. There are two different projects in this area. Firstly at a small level- where electricity companies buy the produced energy at a high price- people must invest more in this, it’s very profitable. Another project- much larger in scale- is the export of electricity to Northern Europe. Germany for example, has decided to close-down its nuclear industry. That creates a huge electricity deficit, and there is the potential to produce a large amount of renewable energy in Greece and export it to countries like that. Projects like this require pan-European investment, at the multi-billion Euro level.
Q: What are your views on Greek sovereign debt?
[Prof. Nicholas Economides] At this point- it is a risky investment.
Greece sovereign paper is- to a large extent- out of the financial markets. It will not do any major debt issues for the next few years. The only issues that take place are short-term 3M, 6M and so on…
There is investment potential in the secondary market for Greek government bonds- but this presents two risks. Firstly is the Greek macro-financial and fiscal situation- if it improves? there would be very substantial returns for investors due to the high rates on these instruments. You also have a Euro-risk that is highly correlated with what happens in Spain and Italy. It’s also highly correlated with actions of the European Central Bank… does it buy sovereign debt in open market operations or not?
This week Mr. Draghi went back and forth on this…. remaining non-committal. The financial markets were extremely volatile because of his words.
On the European front, the real solution would be to create a much larger set of rescue mechanisms based on the ESM and EFSF- and to allow such mechanisms to intervene in the markets for foreign debt. In the absence of such actions, it falls to the ECB- who are not quite sure whether or not they should be intervening in markets… and that creates a whole different problem! This is not just a problem for Greece, but a problem for all the countries in the Euro Zone.
Q: What do you see as Greece’s role in the global economy?
[Prof. Nicholas Economides] China has already bought the operations of the two largest ports in Greece. The country has also expressed interest in buying a Greek bank and the Greek Railroad Company (which is very heavily in debt). I don’t see the nature of Greece’s role within the European Union changing in any significant way as a result of such foreign investments.
Greece is at the edge of Europe- close to the middle-east and with sea-borders to Israel, Libya and so on. To its East, it has the traditional adversary of Turkey- and to the North? the Balkans, with whom it has always maintained relatively good relations. It’s in the centre of relationships between Europe and countries that are either not in Europe, want to be in Europe or have a recent agreement with Europe such as Romania, Bulgaria and so on. This is an important geopolitical role, and it’s in the best interest of Greece to remain part of Europe and NATO- providing stability in a region which has been plagued with political and other issues.
Greek businesses have profited significantly from the nature of the country as being a stable platform in the region.
Q: What is your outlook for the next 5-10 years on the Greek economy?
[Prof. Nicholas Economides] A lot of negatives have already happened in Greece, and now there is an opportunity.
If Greece gets serious about privatisation, reducing the state sector and collecting existing taxes… if these things are done, whilst also reducing democracy? Then I believe Greece will emerge as a very significant success story. It could get the primary deficit eliminated in two years- creating a surplus. The country has also written-off a significant part of its debt, bringing interest rates down to 2.5-3%.
Once the turnaround happens, there are significant profit opportunities- not just from holding sovereign debt, but by holding general assets. Most Greek assets have been going down in price at some time, and if you happen to hold the right assets? You’ll make a killing!
What does this mean for investors and risk managers?
Greece is faces many paradoxical battles. This is a nation which can grow itself out of recession, but which is crippled by a legacy of bad economic and political management. This is a nation which thrives with entrepreneurship, but where businesses struggle to grow. This is a nation which- for millennia- has been an economic pioneer, but now faces the wrath of a world eager to find scapegoats for a crisis we all created.
As Prof. Economides outlined, there are many ‘big‘ decisions needed by the Greek (and European) governments. Decisions which will be hard to implement, hard to gain support for- but for which there are no alternatives. We must remain confident that governments will act in the only way they can- because (to be absolutely frank) they have no option.
In my 2010 article ‘Thinking Ourselves into Another Recession‘ I described how “…When we talk of economic confidence, business confidence, or even confidence in global markets, we are talking of the mindset of the majority of participants in that market. In a ‘booming’ market, participants feel happy, with little sense of risk- so they are happy to invest in their businesses, create jobs, buy property, and drive strong economic figures. In a recessive ‘bust’ market, we see a standard human predator response, “a flight to safety” where participants hoard their capital, run towards safe assets, cease creating employment, cease purchasing property, and create an overall dip in economic figures. The important lesson, therefore, is for us to realise the psychological battle the economy is facing- being a state of collective depression, with markets moving through a daily motion of binge and purge- leading to either a collapse into increasing volatility, or… if we collectively gain positivity, a move towards greater wealth, and economic success. ”
We as investors and commentators must realise that for us to survive, we must (regardless of government interventions) invest and support economies with the will and capacity to grow, but who have been injured by a crisis that we call created, and we all face.