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Goldman Sachs: Greek economy had started to adjust in a substantial way

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In a Global Markets Daily from last July Goldman Sachs first highlighted that the most recent data indicated that the Greek economy had started to adjust in a substantial way.

According to a new report published on September 14th the bank says that the most recent data continues to point in that direction:

1.      The August budget deficit numbers came in well ahead of targets. The primary deficit for the first 8 months of the year came in at EUR1.3bn (about 0.6% of GDP) vis-à-vis a target of EUR4.2bn for the period and compared with a near EUR6bn deficit over the same timeframe last year. This is despite a EUR2bn decline in revenues which was mostly due to cyclical forces. Most of the savings came from primary budget expenditure reduction but the public investment budget was also cut. Given that this data is calculated on a modified cash basis, it is subject to future revisions on the final accrual budget report at the end of the year. However, we do not expect the deviation to be too large or to offset the bigger picture of a budget adjustment that is currently on track.

2.      According to EU data, as of Q1 unit labour costs in Greece have declined to levels last seen in 2000 relative to EMU17 unit labour costs (we used a dummy variable regression to seasonally adjust the Greek data). This is the result of a substantial reform in labour markets that took place in September and had direct consequences for private sector wages. Anecdotal evidence is for further wage reductions in the interim period. This is all evidence that the internal devaluation process has helped Greece regain most of the competitiveness lost over the past decade, at least in labour market terms.

3.      Despite the tight credit conditions for Greek exporters, the goods and services trade balance has continued to improve and to hover at a monthly seasonally adjusted deficit level of about EUR600mn (on a 6mth rolling average basis), much lower than the prevailing levels in mid 90s prior to EUR entry. At the peak of Greek imbalances, the same trade deficit metric was at EUR2.3bn monthly. As we discussed in our piece mentioned above, part of the correction is cyclical and hence not necessarily linked to a structural improvement in the prices of the tradable versus non tradable sectors. That said, combined with the evidence of unit labour cost declines, it is reasonable to assume that a significant chunk of the improvement may be structural as well.

Market is now starting to acknowledge the progress

In our July piece Goldman Sachs argued that Greek assets were trading at levels consistent with significant market concerns for imminent tail events and did not fully reflect the improvement in Greek macroeconomic indicators.

Since then, the Athens stock exchange has performed strongly, posting gains of 28.5%. Over the same timeframe, yields of restructured Greek government bonds have declined by 500bps. The reduction in the Euro area risk premia has largely contributed to the rally. The most recent encouraging policy statements from Euro area policy makers on the possibility of an extension of the Greek package have also supported the market.

But risk premia in local assets remain elevated overall and do not fully reflect the improvement in local fundamentals and the possibility for further improvement in the months to come as the adjustment programme for Greece starts to produce more concrete results.

According to Goldman “to be fair, investors are unlikely to focus on fundamentals solely as long as the tail risk event of a potential broad default and redenomination still looms”. At least for the medium term, this risk will decline if the Troika report paves the way for the disbursement of the next tranche of bail-out funds (worth EUR31bn). The task is high as the Troika demands are quite painful including a further budget adjustment of 5.8% of GDP for the next two years.

So far, however, the Greek government has signalled that it is willing to do all it can to avoid a systemic collapse of the economy. And Euro area policy makers appear willing to continue to provide funding for Greece as long as it meets its obligations credibly.
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