The world’s financial and equities markets went into a tailspin at the start of this week on news that the ratings agencies have downgraded the sovereign debt papers of Greece and Portugal.
The sovereign debt papers of Greece were most severely downgraded. They were reduced to junk rating in the face of that country’s fiscal woes.
As I wrote a couple of times previously, Greece has been brought to the brink of default on its debts by years of massive deficit spending. All efforts to restore a modicum of fiscal moderation in the land of Aritotle have been met with populist agitation and rioting in the streets.
In many ways, Greece is like us. The country’s politicians have, for years, bought popularity by recklessly giving up revenues and subsidizing public services. As politicians are everywhere, the Greek variants are always reluctant to raise taxes and always ready to spend on the public’s every whim.
The paradise of low taxes and heavy public spending was unsustainable. It always is. At some point, the debt will be too large to service and the emergency financing too costly to access.
When the threshold of financial sustainability is reached, lenders will be reluctant to extend loans. The possibility of default looms. When it does, the financial institutions that had previously lent money to a country unwilling to exercise fiscal discipline will be in trouble. They will be left holding debt papers that are virtually worthless because the borrower has no means to redeem them. The stock values of these financial institutions will soon begin to drop.
Greece’s fiscal woes are not only undermining the viability of the financial institutions that lent money to the flailing country. Because Greece belongs is part of the European Community, its troubles infect its partners as well. The value of the euro has been sinking the past few months due to the possible debt crisis in Greece.
Germany, among a few others, expressed willingness to support a bailout package for Greece. But that bailout package is contingent on measurable indicators that the government in Athens is ready to restore some fiscal sanity to its accounts. There is little sign of progress on this matter. Therefore, there is little sign the bailout money will be forthcoming.
Greece is locked in a difficult dilemma. If it restores fiscal order, the government will probably be overthrown. If it does nothing, the country will be bankrupt.
The shockwaves are already being felt. The financial crisis in Greece has already affected the price of Republic of the Philippines bonds. Our financial institutions are now feeling the effects of that — especially since Manila has already reported a higher than expected deficit for the first quarter of this year.
Over the next few days, we should expect tightening of the global financial markets over the Greek problem. Appetite for risk taking will rise sharply. The global economic recovery, which seemed surprisingly strong in the first quarter, might now begin to flag.
The nightmare scenario is a domino effect, producing a condition akin to the financial meltdown we saw in 2008. If that happens, we will see another situation where the profligacy of one economy results in a financial tsunami that adversely affects all the other economies.
The problem in Greece is not just a European problem. It is a global problem.
The alarming thing is that we are almost as vulnerable as Greece is. We have actually done very little to resolve our chronic deficit problem. Under the guise of a stimulus package, we have dared to stretch the acceptable bounds of fiscal responsibility in the hope that a world battling recession will be more tolerant of higher inflation and higher deficit levels. That might not be a workable assumption.
This being an election year in our country, it is not likely that our politicians will be inclined to talk much about fiscal prudence. They are disposed to talk about negative revenue measures like senior citizen exemption from the VAT, promises of no new taxes forthcoming or even lowering the VAT rate.
I have been frequently dismayed, over the past few weeks, listening to some of our candidates attempt to win the votes of the ignorant by saying stupid things like attacking the VAT or calling for unilateral debt moratoria. They are exploiting the low level of financial literacy among our voters to win popularity. In the process, they are raising expectations for policies that will bring us exactly to where Greece finds itself at the moment.
The most urgent strategic concern on the horizon is fiscal sustainability. But none of the candidates feel inclined to discuss that this campaign. They do not feel comfortable discussing with our voters the need for policies that will surely cause pain in the short run but will ensure we are a responsible member of the global financial community.
It is not easy curing decades of fiscal irresponsibility. For generations, our political leaders have found it easier to borrow money than to raise revenues to cover our spending needs. For generations, we have cultivated a public opinion that sees government spending as the main impetus for economic growth and the principal provider for our poor.
Government can, of course do that. It can be a driver of growth and a caring institution. But that costs money. We should be prepared to deal with the volume of revenues required by that image of the state by taxing more rather than borrowing more.
Like the Greeks, we have a population that might potentially riot in the streets when fiscal prudence is observed. It is easy to blame corruption — although this is not a structural source of our fiscal weakness. The structural source is that we have an unduly long public payroll even as we have among the lowest tax efforts in the world.