Greece needs Dubai-style restructuring

After weeks of theatrics, the euro support package, when announced, was unexpectedly impressive on paper. In the lurid prose of a relieved euro zone foreign minister, the snarling wolfpacks (lurking in currency trading rooms around the world) had been kept at bay.

They hadn't. The euro dutifully hypered upwards immediately after the deal was announced. It took about a day before the wolfpacks' back room boys deciphered the script between the lines. Upon which the packs forced the euro to hypo into depression. The currency has had gag-inducing yo-yos ever since. The currency traders of the wolfpack thrive on volatility – their strategies (very basically) revolve around short-selling when high and buying when low. With the Chicago Board Options Exchange (CBOE) euro currency volatility index jackknifing up by 50 per cent plus since early May, this is a currency trader's heaven, a once-in-years pack feeding frenzy.

A lot of day-to-day volatility is, of course, driven by transient sentiment – say a minister's comment here or the announcement of an economic statistic there. These passing events – and there have been many pronouncements, positive and negative, in the past few weeks – these cannot explain the sheer scale of the euro's recent fluctuations.

Ministers have shot off their mouths in the past, and economic numbers have undershot or exceeded consensus forecasts, without provoking the violence of the currency's recent moves. There is much more at play here, factors that make the entire euro structure rickety enough to teeter with every passing breeze, to swoon at any mildly negative sentiment, to cheer giddily for anything not negative, deep structural uncertainties. The euro's downward trend is a given in view of the zone's troubles; its wild oscillations while going down are caused by these uncertainties. Here are a few of these.

The Greeks….

The foremost, inevitably, continues to be the Greek conundrum. There has been relatively little public debate on the dodgy maths behind the Greek deal, but here is a gist. As per the modelling on which the deal is based, Greek debt to gross domestic product (GDP) figures will continue to rise until 2013, peaking at about 150 per cent of GDP in that year. At an average interest rate of even five per cent, this debt will then consume 7.5 per cent of GDP in interest payments alone. A Chindia-like 7.5 per cent is, of course, well beyond what the Greek economy can be realistically expected to grow at. Which means that just to service the interest, the free-spending Greeks will now have to run a substantial budgetary surplus.

To get to that happy state, here's what their government has promised to do: severe bonus, salary, overtime, allowance and employment cuts in the public sector (where one in four Greeks work); a reduction of 66 per cent in the number of public sector enterprises; drastic public spending cuts; punitive taxes on and cuts in pensions; substantial increases in luxury, income, wealth, value added, corporate, retail and establishment taxes. (Etc etc – there's more). The barrel's been scraped so hard that the bottom's been holed. (And we haven't even got around to discussing principal repayments yet).

Unfortunately, to make the model run, not just a few, but very many of these measures have to succeed in tandem, and substantially. The thinnest sliver of the wedge, the first economic austerity measures announced, were enough to cause the recent mass outrage. Odds, anyone, on social and political upheaval in Greece derailing the deal's economics within the next three years?

The canker festers and will not be lanced until Greece has a Dubai-style debt restructuring in place, perhaps even a write-down. As long as the euro zone is in denial of this fact, uneasiness about its fundamentals will remain, and its currency will continue to fluctuate wildly.

….and the others

And, lest anyone forget, the Those In Need (TIN) gang waits in the wings. As a percentage of its GDP, Portugal's external debt burden is bigger than Greece's at 200 per cent, and its current account deficit is in double digits. Spain has a budget deficit and external debt figures similar to those of Greece, and crucially, large redemptions coming up. No one knows exactly how much of Ireland's external debt – ten times its GDP – can be attributed to a hyperactive banking sector; the jury's out on whether the recently announced austerity packages can curb the country's spending deficits. Italy has a government debt of more than 100 per cent of GDP, and a high interest burden.

These TINs – one ? two ? a few? – are readying their own tins for handouts, and deals substantially more stringent than Greece's will obviously be politically difficult to ram through. If Greece has not bitten the restructuring bullet by then, how and why will the others? Translation: further uncertainty and volatility for the euro.

The biggest unknown is what has been little debated (as yet) – the soundness of the euro zone's two buttresses, Germany and France. Both countries are massively indebted – their external debts for example, at 155 per cent of GDP for Germany and 188 per cent for France, comfortably make the world's top five. This means that the euro support package would have been the hugely indebted bailing out the hopelessly bankrupt, had it not been for the saving graces of budgets and current accounts in control in the two countries. That's for now. An unstable currency could easily see interest premiums for all zone countries spike, taking with it the Franco – German financial cushions.

There's also the question that is starting to be asked insistently, if not loudly as yet, of dodgy assets in the banking systems of both countries. Both have avoided a hard look at write-offs for years, and an honest audit and write-downs would add up to a sizeable proportion of their GDPs. Further nervousness; further volatility.

Fortunes will be made in trading the euro's lush swings over the next few months.

- The writer is a senior executive with the National Bank of Abu Dhabi. The views expressed are his own

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