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Why does the primary surplus exclude bank recapitalisation?

Debt burden has increased as result of bank recapitalisation, prolonging the problem that caused the government to call in the troika

Greece's primary surplus for the targets of the troika's Economic Adjustment Programme (EAP) varies significantly from the standard definition used by Eurostat, which has some benefits and drawbacks for the government, says Simon Davis

A man sits outside a National Bank branch in Athens (Photo: Reuters) A man sits outside a National Bank branch in Athens (Photo: Reuters) People watching the April 23 European Commission press briefing with Simon O'Connor, its spokesperson for economic and monetary affairs, were treated to a bit more information than the headline reported by most news media and indeed his own tweet on the matter. Namely, the achievement of a primary surplus for 2013 of 0.8% of GDP for Greece, which surpassed the troika target of 0% and which paves the way for the disbursement of the next tranche of bailout funds.

Namely, O'Connor laid out a summary of how the commission arrived at their primary surplus figure of 0.8% of GDP when the Eurostat reports a primary deficit of 8.7% of GDP (a difference of 9.5% of GDP or about €17bn).

The Wall Street Journal provides the breakdown in more detail, but the short version is that Greece's primary surplus for the targets of the troika's Economic Adjustment Programme (EAP) varies significantly from the standard definition used by Eurostat.

By far the largest item not to be included is the 10.8% of Greek GDP that was spent in 2013 to recapitalise the Greek banking system as a condition of the latest bailout. As zerohedge succinctly put it:

What is the significance of this however?

The different definitions are not new. I had written about this in quite a bit of detail two months ago (see below) after the finance ministry announced the EAP definition primary surplus and - with much less fanfare - the Eurostat definition primary deficit for 2013. However, it was an important part of the last bailout agreement which called for up to €50bn in cash injections from the Greek government for the bank recapitalisation fund to make up for their significant losses on government bond holdings due to the private sector Involvement (PSI) programme. It was only a matter of time before commentators began to notice once the recapitalisation began in earnest. It should be noted that the government has acquired ownership in banks which have been deemed viable. However, the value of these holdings will not be reported until next August, and will likely change over time. Commentators should be cautious to factor this into their assessments, even if there is no figure reported yet.

It's doubtful that this was done solely due to the large size of the amount needed for the bank recapitalisation. Relative to the economy, the Irish bailout agreement required much more government assistance for the banks than did the Greek one, and the programme targets there were on the exchequer primary balance (comparable to the central government primary balance in Greece) and included the bailout funds going towards the banks. It's even more doubtful that the troika expected to "hide" up to €50bn from public view, notwithstanding the fact that it used established terminology for a programme-specific metric.

What can be said with a bit more confidence is that this arrangement does have some benefits and drawbacks for the Greek government.

The benefit is that it effectively "decouples" the bank recapitalisation - which is administered independently by the Hellenic Financial Stability Fund (HFSF) - from the government's budget targets. What this means is that the government does not have to depend - strictly speaking - on the banks meeting their targets. The government can instead be judged by the troika on benchmarks that it has a greater degree of control over, namely the performance of its own finances. As mentioned previously, this is something that was not the case in Ireland, though in Greece's case the bank assistance had to happen later on the programme and included a bond haircut, which made made the outcome more uncertain. By contrast, the Irish government had already bailed out its banks and the troika programme was the last such cash infusion.

The main drawback is that the Greek government's debt burden increases as a result of this assistance, thereby prolonging the problem that caused it to seek assistance in the first place. While the PSI did indeed reduce the amount of outstanding government debt in private hands, the fact that already strained Greek banks held much of it meant that new debt had to be taken on by the Greek government - this time owed to the official sector and with much more restrictive rules than its old bonds - in order to soften the blow to the Greek financial system. This is a big reason why Greece's debt to GDP ratio remains so high today. In addition, the government budget process has a certain level of democratic legitimacy and transparency (albeit under pressure to enact harsh and unpopular policies as a condition of receiving funds). By contrast, the HFSF is a private entity which only reports results once a year with a fair amount of delay (which then also leads to the government budget results having to be re-stated) and with much less oversight.

* Follow Simon Davis on Twitter @SimonKnowz and Facebook. His site is at simonknowz.com


Editor's note: Below is Simon Davis' analysis from February 22 discussing the two different primary balances. It was originally published at ThePressProject International and is reposted here with permission. The translation was by Pavlos Zafiropoulos.

The Greek Primary Surplus Handbook

 22 February 2014

In Greece's ongoing negotiations with its troika of lenders of crucial importance is the primary budget surplus the government claims to have achieved for 2013. Yet despite the central significance of the surplus it is still the source of intense disagreements. What is the primary surplus and how is it calculated? And how big is it really?

Last week [ie mid February 2014] saw at least two public clashes and one official announcement (link in Greek) regarding the primary surplus (or more generally the primary balance). In the majority of countries that would occur perhaps once every quarter and there certainly would not be public disagreement over the accuracy of the official statistics. In Greece in 2014 however, it is almost a weekly occurrence. With so many different numbers and so many different reports it is not surprising then that readers often find themselves at a loss (as do many journalists) over what the primary balance actually is and how it is calculated. What follows is a guide for the uninitiated.

What is the primary balance and why is it important?

Every country has revenue and expenditures that are recorded on a monthly, quarterly, and annual basis. Expenditures include spending on wages, pensions, goods, and services. Taxes usually make up the largest part of revenue. The primary balance is equal to revenue minus expenditures and is either in surplus (+) or deficit (-) for a particular time period. If expenditures are greater than revenue, then there is a primary deficit, if the opposite is the case, then there is a primary surplus. Since it fluctuates, it is simpler to refer to it as the primary balance unless it's already known if it has a negative or positive value.

The primary balance does not include national debt servicing costs (principal and interest). The primary balance is not the same as the budget balance, which does include debt payments and is also calculated at regular intervals. When the terms "deficit" or "surplus" without an additional qualifier are used, they are in reference to the budget balance, not the primary balance.

The existence of a primary surplus affords a country the opportunity to begin paying off a portion of its debt. In the event of a primary deficit it must borrow more to meet its expenditures. Unlike most other countries however, Greece lost the ability to borrow from the markets in 2010 due to its excessive debt. Therefore it must - under strict conditions - borrow from the European Union and the International Monetary Fund (these are the so called memoranda of understanding with the troika). One of the conditions for this borrowing to be continued is that specific yearly targets are met for the primary balance (specifically its size in relation to the size of the economy).

That is the main reason that there is so much attention paid to the primary balance. Its calculation, however, is far from a simple task.

How is it calculated and by whom?

There are two main methods of calculating the primary balance: cash-based and accrual. The European Commission explains the differences:

  • In cash accounting, transactions are recorded only when cash is received or paid out. Cash accounting does not distinguish (whereas accrual accounts do) between the purchase of an asset and the payment of an expense — both would be simply "payments".
  • In the accrual accounts, transactions are recognised when they occur: if an EU-funded project sends a bill in December, it will be recorded that month, even if the payment is to be made the following year.
The differences between the two methods above may result in significantly different results. For example with cash accounting, when the state delays paying its suppliers, it may receive goods and equipment yet the expenses will not be recorded until the bills are paid. In contrast, with accrual accounts the expenditures are registered on delivery of the goods.

The official European statistics for the Greek state are produced by the Hellenic Statistical Authority (Elstat). When Elstat - which since 2010 is no longer a branch of the finance ministry but operates as an independent body - announces data with a delay of several months, it has been calculated according to the method of accrual accounting. The methodology it uses is the European System of Accounting (ESA 95). For instance, the data for the final quarter of 2013 will be published in mid April 2014. Eurostat uses the same methodology for the calculation of primary balances. The equivalent data that is registered by Eurostat every quarter comes directly from Elstat. The data produced by Elstat is for the general government sector which is different from what we normally term the "state". Specifically:

"The general government sector includes all institutional units whose output is intended for individual and collective consumption and mainly financed by compulsory payments made by units belonging to other sectors, and/or all institutional units principally engaged in the redistribution of national income and wealth. The general government sector is subdivided into four subsectors: central government, state government, local government, and social security funds." (From Wikipedia)

On the other hand, when the finance ministry announces results a few weeks after the end of each month (i.e. sooner than Elstat), the majority of these have been calculated according to the cash method although it also makes some estimates using the ESA 95 methodology (amongst these are calculations of the primary balance). The ministry also uses a different questionnaire from Elstat. Furthermore the ministry publishes data from the state budget and the general government sector separately.

Thus, the ministry regularly announces two different primary balances (one for the state and one for the general government sector) and with two different methodologies (cash accounting and ESA 95). Subsequently Elstat follows with its announcement for the general government sector with ESA 95 figures based on its questionnaire. This is why different figures, even for the same time frame, are published yet all of these are often labelled simply "primary balance". With this in mind, it is not surprising that there is confusion about which is the correct figure.

Which is the primary balance that matters when it comes to the memorandum targets?

The definitive data for the primary balance is that which is calculated by Elstat for the general government sector and which is definitely the most reliable. For the period prior to the publication of the Elstat data, the equivalent Finance Ministry figures (calculated using the ESA 95 methodology) are also used in negotiations with Greece's lenders.

Yet here is a final "but". The targets of the current memorandum do not apply strictly to the primary balance of the general government sector. The specific balance used (according to the "programme definition", click here for a short description, page 5) has certain modifications. It explicitly exempts public expenditure in the form of assistance to the banking sector, revenue from the profit transfers of the ANFA and SMP bond programs and revenue from sales and leases of state owned real estate assets. For 2012 and 2013 by far the most significant expenditure / revenue exempted was government spending on banks.

This is why there may be a "memorandum" primary surplus while the true balance is a primary deficit due to the large state expenditure on the banks. That is exactly the situation that exists today.

What is the impact of state support of the banks?

The majority of the state recapitalisations of the banks via the Hellenic Financial Stability Fund (HFSF) began in mid 2012 and were completed in April 2013. Through these recapitalisations the Greek state obtained large majority stakes in four banks deemed viable, but this came with increased costs as the state adopted a more active role than that of guarantor of their debts (as was the case previously). For this reason we see for the first time during the period 2012-13 a negative amount showing up on the national accounts due to the support of the banks as opposed to the period 2009-11 when revenue from the preferred shares and the accrued fees from the guarantees of interbank lending were higher than the accrued expenditures.

Note: When the annual financial statement of the HFSF is published for 2013, it is certain that the height of state support will be revised downwards to take into account HFSF losses, as occurred in August 2013 which led to a significant revision of Elstat's statistics for 2012. This in turn will provide the final picture for the true primary balance of 2013. Something which means that until then the figures A and B below for 2013 must be treated as temporary, even if they have been published by Elstat and the ministry. What follows is a summary of the relevant statistics for the past five years.

(A) General government primary balance (-) deficit / (+) surplus

2009 ‐€24.190bn
2010 ‐€10.860bn
2011 ‐€4.981bn
2012 ‐€7.771bn
Jan-Sept 2013 -€17.026bn
Jan-Dec 2013 -€15.414bn (Finance ministry figures)

(B) Effect of financial assistance to banks

2009 €373m
2010 €960m
2011 €622m
2012 -€5.495bn
Jan-Sept 2013 -€19.626bn
Jan-Dec 2013 -€19.314bn (Finance ministry figures*)

(C)=(A)-(B) The "memorandum" general government primary balance (-) deficit / (+) surplus

2009 -€24.563bn
2010 -€11.820bn
2011 -€5.603bn
2012 -€2.276bn
Jan-Sept 2013 €2.600bn
Jan-Dec 2013 €3.900bn (Finance ministry figures)

Source: Elstat [1] [2] | Finance ministry (in Greek) [3]

The calculation was done on the basis of the ministry's announcement (link in Greek) that 2.1% of GDP for 2013 = €3.9bn (C) which implies a 2013 GDP of €185.714bn. The announcement does not refer to a specific height of the primary deficit but only the 8.3% of GDP. Therefore A was calculated as -8.3% of 2013 GDP. The amount of financial assistance to the banks (B) was calculated as (A) - (C).

* May include €2.715bn in revenue from profit transfers from ANFA/SMP programme (source: General state budget, 2013) which if true would mean a greater level of spending on the banks. However it is not clear from the announcement.

Conclusion

For the reasons outlined above, until the final financial statement of the HFSF for 2013 is released in August, the situation appears quite fluid and it is difficult to make reliable predictions over the height of state financial assistance to the banks (which includes not only the amount of public spending but the value of the bank assets acquired). Given that this is a very significant part of the budget as calculated by the accrual method, only when this happens will there be a clearer picture of the actual primary surplus which will certainly be revised downwards.

On the other hand, the data that show that the "memorandum" primary surplus is €3.9bn appear reliable as they do not include the activities for the recapitalisation of the banks. Although it is expected that the Elstat calculated surplus released in April will differ from the ministry's figures, it is almost certain that it will surpass the memorandum target of €0 for 2013.

* This analysis was first published in Greek on SimonKnowz.com

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