SCENARIOS-Can Greece cut its deficit by 10 points in 2 years?

By Harry Papachristou and Michael Winfrey

ATHENS, April 29 (BestGrowthStock) – Greece, the IMF and the
European Union are discussing austerity measures aimed at
cutting the country’s deficit by 10 percentage points of GDP in
2010 and 2011, labour union leaders said, a goal that could
deepen recession and spark a public backlash.

Labour union leaders said the measures under discussion
include more tax hikes and even steeper cuts in wages and
bonuses than announced by the government last month, as well as
the elimination of full-time jobs in the public sector.

The new budget objective would exceed the country’s current
target of cutting the deficit by 7.1 percent of gross domestic
product in two years — from a 2009 level of 13.9 percent of GDP
— and push forward its goal of bringing the shortfall to near
the EU prescribed level of 3 percent by 2012.

In a three-year stability and growth plan agreed with the
European Commission, Greece planned to narrow the budget
shortfall to 8.7 percent of GDP this year and bring it to below
the euro zone’s 3 percent by 2012.

Based on the labour leaders’ statements, conversations with
analysts, fiscal targets set out in the stability and growth
plan, and comparisons of other EU/IMF bailouts, here are three
scenarios Greece faces, with implications for financial markets:

GOVERNMENT MEETS OR EXCEEDS FISCAL TARGETS

SCENARIO: Helped by extra austerity measures and a crackdown
on waste and tax evasion, the government manages to cut the
deficit by 10 percentage points by the end of next year.

PROBABILITY: Very low. Further austerity measures are
expected to hurt an economy already in the doldrums. The IMF
already expects the economy to contract by 2 percent this year
and by 1.1 percent in 2011, making it Greece’s longest recession
in 30 years. Some economists expect domestic demand to contract
even more, by about 5 percent.

Additional belt-tightening would hurt the economy further,
analysts say. That would undermine income tax revenues and make
it tough for the government to achieve its already ambitious
target of boosting net tax income by 11.7 percent this year.

MARKET IMPLICATIONS: A deficit cut of 10 percentage points
within two years would be a positive surprise for investors and
make it easier for Greece to tap financial markets sooner,
perhaps even next year.

GREECE WIDELY MISSES BUDGET TARGETS

SCENARIO: The economy shrinks by more than 4 percent, with
tax revenues collapsing and Greece widely missing its deficit
targets.

PROBABILITY: Average. Recession deeper than 4 percent with
unemployment rate soaring well past the 12 percent is expected
to intensify social unrest and could prevent socialist Prime
Minister George Papandreou’s government for pushing reforms, and
labour unions have already vowed to resist further austerity.

Even without social unrest, cutting deficits in times of
economic downturn is extremely difficult, as shown in the
examples of three non-euro-zone EU states that pledged to trim
public finance shortfalls as part of EU and IMF aid packages.

Latvia agreed with the IMF to aim for a fiscal deficit of 5
percent of GDP last year but ended with almost double that after
austerity measures exacerbated an economic contraction of 18
percent that was more than three times worse than forecast.

IMF borrower Romania also saw its deficit rise from an
original pledge of 4.6 percent of GDP in 2009 to 8.3 percent,
and Hungary originally pledged to a 2.9 percent of GDP deficit,
but finished at 4 percent. All three had to renegotiate targets.

MARKET IMPLICATIONS: Political instability in Greece would
destroy any hope of Greece managing its debt, increasing the
prospects of a debt restructuring or default. This would raise
pressure on Greece to withdraw from the euro zone, at least
temporarily, and could undermine the credibility of the European
single currency. It would also raise market pressure on euro
zone periphery states like Portugal and Spain, potentially
making it more expensive for them to borrow.

GREECE CUTS DEFICIT MODERATELY, MISSES TARGET

SCENARIO: The new measures lead to even deeper recession but
the size of the tax increases and spending cuts are too great to
allow the government to narrow the deficit by 10 percentage
points of GDP over two years.

PROBABILITY: High. The Greek public sector is in such
disarray that even elementary spending and structural reforms
could generate significant deficit cuts, even in case of very
deep recession. The government has already legislated wage and
pension cuts in the public sector of about 2.7 billion euros.

Defence spending cuts of 460 million euros are also
underway. The government has capped pharmaceuticals prices by
about 1 billion euros to limit hospital spending. The EU has
pledged to speed up disbursement of an extra 1.4 billion euros
earmarked for infrastructure.

A new hike of VAT and excise taxes would help Greece exceed
a current target of an additional 6.1 billion euros in revenues
from VAT and other taxes this year,

But deeper recession would mean higher unemployment and cast
doubt on plans to reduce social security subsidies by at least
540 million euros and raise about 1.7 billion euros by cracking
down on tax evasion.

MARKET IMPLICATIONS: A deficit cut of 3-4 percentage points
per year would not be a surprise but would create the impression
that Greece has fallen short of its targets, shaking further
investor confidence and delaying the nation’s return to markets.

Stock Market Today

SCENARIOS-Can Greece cut its deficit by 10 points in 2 years?