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Sovereign Debt: Emerging Markets and Developed Nations

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Optimism may be surfacing in the Eurozone, and many officials may have backed off their original tough stance on austerity, but Greece is still battling its debt demons. However, it doesn’t look likely to fall off the cliff in the immediate future.

At Davos this past January, doomsayers from Nouriel Roubini to Kenneth Rogoff were reminded of their predictions at the January 2012 meeting of the World Economic Forum, and after, that Greece would surely be gone from the Eurozone by now with the joint currency’s very survival in doubt. Neither a Greek exit nor the chaos that would have ensued has occurred, however.

Instead, a declaration last summer from Mario Draghi, head of the European Central Bank, that he would do “whatever it takes” to keep Greece in the Eurozone was followed in the fall by an ECB bond-buying strategy that seems to have poured oil on troubled market waters—even though it has yet to be used. Interest rates have fallen, while speculators who bought Greek debt in January of last year and held it made out like bandits, reaping what Bank of America Merrill Lynch indexes indicate as a 78% return. German Bunds only returned 4.5% for the same period.

In addition, a relaxation in austerity demands appears to have lessened the likelihood of a Greek departure from the euro, as some of the more prosperous Eurozone countries have acknowledged the need to concede that approach as flawed as they moved toward more joint action to preserve the region’s currency.

That doesn’t mean thatGreece’s problems are over, of course. It still staggers under a mountain of debt—predicted by the European Commission to hit 174% of GDP this year—and a crippling unemployment rate of 26.8%. It has also been battling to enforce tough austerity measures on an unwilling populace—everything from tax increases to job, salary and benefits cuts to crackdowns on tax evaders—with dubious success.

Its efforts to impose conditions required by the European Union in exchange for bailout funds have led to demonstrations, some violent, and strikes that have intermittently shut down the already beleaguered economy in areas ranging from tourism to medical care. Scandals over tax evasion and the so-called “Lagarde List” of 2,000 members of the government, past and present, who secreted cash in Swiss accounts rather than pay taxes on it have further fanned the flames of rebellion, according to published reports.

However, somehowGreecehas muddled through to be approved in December to receive the latest tranche of rescue funding—49 billion euros’ worth ($57 billion) of cash to keep the country going as it strives to right its ship of state. Also approved was a two-year extension of the deadline by whichGreecemust reduce its debt to within International Monetary Fund-prescribed limits, as economists have begun to rethink austerity policies and their effect on a depressed economy such as Greece’s.

On January 8,Germany’s Macroeconomic Policy Institute (IMK) issued a report that said austerity programs were counterproductive to already-depressed economies and that wage increases would be more effective in battling growth problems.Germany, of course, has been one of austerity’s staunchest supporters. 

Also, just the week before, Olivier Blanchard, the IMF’s Chief Economist, together with David Leigh, an economist colleague, said in a research paper that IMF forecasters had used an incorrect multiplier when calculating the effects of austerity on the European economy. Austerity therefore took a far greater toll than Blanchard and Leigh had originally predicted, whereas countries that had implemented stimulus programs did better than predictions indicated.

Some countries, of course, likeGermany, are still determinedly in favor of austerity as a means of combating the debt crisis—despite the evidence of its failure in places likeGreece,SpainandItaly. EvenGermany’s own economy is slowing, and an austerity plan of its own looks likely to drive it further backward even as IMK advocates salary increases instead as a stimulus measure. With elections to come later in the year, and Chancellor Angela Merkel and her party facing stiff opposition to any relaxation of austerity demands onGreece, the situation could once again change for the worse.

So what does all this mean forGreecein the coming year? So many factors are still in play—not just inGreecebut in the eurozone—that it’s tough to hazard a guess about what might lie ahead for the ancient country. Still, with funding in place to getGreecethrough the next several months, John Blank, chief equity strategist at Zacks, said that it’s unlikely anything drastic will occur until after the German election.

Any change “this year … withGreece” said Blank, “is not [going to happen] in the first half of the year because of the bailout package, and there’s some expectation of July as [a successful] tourist season.” There’s also, he added, some repatriation of funds going on, with assets flowing back intoGreeceafter flooding out of the country last year. Of course, he pointed out, if officials can successfully crack down on its tax evaders and repatriate additional funds, that would bring more much-needed capital back into the country.

“There’s some evidence of stabilization, but it’s all tentative,” he cautioned.Greecewill need to keep its agreements on austerity measures, make the cuts it promised and sit tight for the German general election in September. The incentive, said Blank, is for political leaders inEuropeto keep the existing policies in place.

“Most likely, through September, we will not see much of this story,” Blank continued. No one will be willing to rock the boat before the German election, since if Merkel and her party continue in power there will likely be little change in existing agreements. However, should she and her party come up short at the polls, that could change things; if Greece does poorly at keeping its side of all the bargains it’s made, it could change things very drastically indeed. “Greecehas just waffled its way through an incredible year [2012],” Blank concluded. “It lost three governments and two elections, and got the biggest bailout in history.” What happens in 2013 is still anybody’s guess.

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