I was at a lunch recently with some economists working for investment banks. The conversation was about PIGS (Portugal, Italy, Greece, Spain) and who coined the derogatory acronym. It has probably been coined by some economist at an investment bank but because it sounds pretty offensive, no bank wants to claim credit, like they did in the case of BRIC (Brazil, Russia, India, China). Italy, for one, has said publicly that it does not want to be clubbed along with the three other nations in the PIGS acronym. The Italian bank, UniCredit, has waged a campaign to change the ?I? in PIGS to Ireland since they know that they can?t stop the rest of the world from using that acronym.
Acronyms can have a fairly long life span. The BRIC concept was first identified by Goldman Sachs in 2001 in a research report, Build Better Global Economic BRICs. These four countries had different backgrounds but one shared promise?they were the economic powerhouses of future. It has been almost a decade since the introduction of BRIC and the acronym is still in currency. The PIGS acronym bunches together four different countries with dissimilar size and circumstances but one shared face?they all face serious budget shortfalls.
Each of those four countries has massive social spending and not as much revenues to cover for it. They have excessive labour costs from expansive public unions, coupled with high unemployment. The remedy that is being prescribed is fiscal austerity and higher taxes. However the question remains, why would current taxpayers be willing to pay for government debt that got built up in the past?
Let us put ourselves in the shoes of the citizens of those countries and try to walk some distance. Hypothetically, if the Narasimha Rao government had piled up huge external debt during the early nineties, I am not sure if current taxpayers like you and me would be too keen to foot the bill by giving away a larger portion of our income to the government. The argument would probably have been?the government excesses and subsidies then were enjoyed by a different class and generation of population, why should you and I have to foot the bill for benefits enjoyed by somebody else. It?s a bit difficult to see the citizens of PIGS reasoning any differently.
Let?s assume that the citizens in those countries were rational and prudent. They are so well informed that they factor in the damaging consequences of a default. Let?s surmise that tax payers in those countries are willing to pay higher taxes to uphold the quality of government credit. The willingness may come from the compulsion that if the quality of government credit remains favourable from the viewpoint of lenders, the rulers and the ruled can continue to take recourse to borrowing money in future times of need. Even with the utopian concept of the masses being rational, the citizens would judiciously not avoid a default, given the current state of affairs. This is because in distressed times, the cost of borrowing becomes extremely high and debt financing becomes too costly and at times, unaffordable for the rulers and the ruled. The CDS spread of Greece, which is a proxy for the risk premium the lenders charge has gone north of 350 basis points. Once issuing new debt becomes too costly, or the debt amount has become too large with respect to their income?the economic incentive for rulers and the ruled to service the debt declines rapidly. Italy has sovereign debt in excess of $2 trillion. The smaller economies like Greece and Spain are running a fiscal deficit in excess of 11% of their GDP. If they indeed were to pay back the debt, an entire generation would have to sacrifice a greater portion of their income to the government. Reneging on the payment may seem to be an easier option. Another way for PIGS to avoid a default could be to roll over debt, that is, postpone the problem to a future time. However, that too is unlikely because citizens of the better off countries like Germany and France won?t be too keen to lend money as they may have to share the losses of their neighbours eventually.
All the four countries have large foreign debt and not much domestic debt?the government has not borrowed much from its citizens. The sovereign debt is predominantly held by those who do not have a direct say in repayment of debt or in setting government policies. The lenders have a say only in monetary policy as they are part of a monetary union. Since the losers will not be their citizens, the incentive for rulers to renege on debt becomes fairly high. The rulers will eventually ask themselves, ?Why engage in the politically unfavourable business of taxing citizens, as neither we nor our subjects can issue any more new debt?? The PIGS are in a precarious position with not much reason, intention or incentive to honour their debt. The acronym may become synonymous to sovereign risk for a long time to come.
?The author, formerly with JPMorganChase, is CEO, Quantum Phinance