Most of you have heard the story about a frog trying to climb out of water well, where for every two steps the frog climbs, it falls back by one step, making its progress arduous. Thus the origin of the known phrase "Two steps forward one step back..."
Back in 1997, Russia came under great financial distress. Falling productivity, an artificially high fixed exchange rate between the Ruble and other foreign currencies, as well as an ongoing fiscal deficit created the perfect storm for a financial meltdown. Furthermore, a political crisis forced then Russian President Boris Yeltsin to replace the Prime Minister Viktor Chernomyrd. Internal debt was rapidly accumulating and in order to attract capital, interest rates were elevated to 150%. But because of “irregularities” in managing government funds, payment of internal obligations such as public employees’ wages, pensions, transportation and communal utilities became a bit of a lottery, some got paid and some didn’t. The IMF stepped in and provided $22.6 billion in aid.
But one year later, 1998 Russia was in even more trouble than the year before. And because the government was unable to implement any sensible economic reform that would solve its mounting fiscal problems, the end result was devaluation of the Ruble, default on its domestic debt obligations and a moratorium of payments to foreign creditors.
Back in 1998, Russian internationally traded bonds reached “junk bond” status and traded around 10% - 12% of their face value. However and thanks to recovering in the prices of oil, natural gas, wheat, mining and other needed commodities, as well as a devaluation of the Ruble and deep budget cuts, by 2000 Russia was well on its way to recovery. A Russian Global Bond with a maturity in 2018, trades today (2011) at 140% of its face value, with a coupon of 11%, thus yielding around 4.25%.
Russia took “two steps forward one step back” and got out of the well!
It’s interesting how history has a stubborn way of repeating itself. Does the above resemble in any matter what Greece is going thru? Before you answer, behold there are great differences.
Greece has a labor force of about 5.05 million (versus 73 million in Russia). And the Greek economy is based mainly on tourism, shipping, industrial products, food and tobacco processing, textiles, chemicals, metal products, mining and petroleum refineries. As the world economy has slowed down, much of Greeks trade is at a deficit due to less demand. Also, Greece is tied to the Euro, and is unable to devaluate its currency, like Russia did in 1998. And most Greeks are used to getting a job in the public sector (about 1/3 of the population is employed by the government), they like to retire at the young age of 61 (the average in most European countries is retirement at 65), and pensions are high (Greece is considered to have the 22nd highest human development and quality of life indices in the world). Yet taxes are very low.
Holders of Greek bonds are mainly foreign entities and a default could have a “spill over” effect on other European countries, so clearly a “solution” will be found to assist Greece in avoiding a catastrophe. When measured against the rest of the world, the size of the debt is not unmanageable, $441 billion or 125% of its GDP (as an example, Japan’s Debt is 228% of its GDP). But the main question will remain: Can Greece eventually get their act together, clean up the fiscal deficit, repay their debt and get back on their own feet? Perhaps, but it will take help, especially from other EU countries as well as a lot of time since the world economy is at a slow down. Don’t expect this problem to go away soon and this means that the financial markets will experience volatility for some time to come.
Will Greece take two steps forward and one back or will the twisted “one step forward two backward” prevail? Certainly we all hope for the first to happen.
