Interview: Jan von Gerich, Nordea chief strategist, about the situation of the Eurozone, the challenges for Finland’s government after the elections and the scenarios for the future

Jan von Gerich is chief strategist (in Finnish “pääanalyytikko”) in Nordea bank. After initial studies in industrial engineering and management in the Helsinki University of Technology (Aalto University), he has worked in different positions in Nordea, in particular as a global strategist. His present responsibilities are covering the Euro area, from the financial markets perspective, but he needs to take into account what happens on other big markets such as the US and China. He is also following Finnish developments, even if it is not his main responsibility. He is giving to Finland Politics his views on the present situation, when the negotiations in Brussels are really beginning.

What is your view on the Greek problem?

It looks quite worrying in many senses. It seemed quite clear from the beginning, or at least during the election campaign, that the Greeks would play an election game saying that they change things and then they would come to their senses afterwards. But now it seems that they are maintaining this line, and it appears that they continue to think they have a stronger negotiating position than they actually do. Whenever this is the case, there is a risk that, even though nobody wants a bad outcome, that nobody caves in, which leads to a bad outcome. It means that the risk of such an outcome is real, and more than most would admit, if you just listen to the official line which is that there is no chance that Greece would end up outside the Euro zone. There is in fact a real risk that Greece may have to end up outside of the euro. But it is not yet the most likely outcome still, because there has been some movement in the Greek position, but quite small steps so far… I would have very hard time seeing that the Euro area would be that flexible in terms of changes to the Greek programme. Or when I say the Euro area, maybe I should talk about Germany, and Spain and Finland… There are anyway large countries with rigid positions, a number of countries, and in these matters you need unanimity: so it is hard if there is that big opposition to give some flexibility to Greece.

So what will happen at the end of February if nothing changes, taking into account the last decisions of the ECB?

Nothing specific will happen at the end of February any more. The biggest thing was that Greece would lose eligibility to normal refinancing possibilities, and that happens this week anyway. And it is pushing a big chunk of Greek banks liquidity needs into the national central bank, which can provide what is called emergency liquidity assistance (ELA). The ECB can block it as well, but they are not going to do that, for the moment at least. It remains a risk, as that money carries a high costs for the Greek banks. So it is an issue for them, but it is not a crucial issue. The crucial issue would be that the ECB shut down the emergency liquidity assistance. That is a possibility as well if the Greeks do not agree on anything. So the threat comes from the ELA.

And the risk is that the deposit flow accelerates in Greece, people withdrawing funds, then that basically means that the banks need to compensate it, and they will most likely compensate with higher liquidity assistance from the national central bank. And as long as the Greek central bank is part of the Euro system, then it is a risk for the Euro system as well. The question will be how long the ECB stands in this situation. This is a risk factor also, that Greece can try to control with capital withdrawing limitations as well. But such flaws could quickly accelerate the crisis.

If Greece is obliged to leave the Euro zone, what will be the impact on Finland?

First of all, nobody is going to push Greece out, it cannot be expelled politically. The mechanism could be that liquidity is cut, then the Greek Central Bank would have no other alternative than start printing a new currency to meet the demand for money.

But then if we come to the direct impact on Finland, it would most probably come from the effect on the euro area economy, because the direct links between Greece’s and Finland’s economies are very limited. But it would hit the euro economy, and as an export-dependent nation, Finland would suffer: it would push economic recovery even further out. Even now we are not seeing a recovery before at the earliest very late this year, so it may postpone it.
If it happens before the election, then it could very much affect the outcome of the election as well.

How do you see it?

It would probably benefit the Finns Party. I do not think it would hit the Centre Party that much: even though they were part of the government who accepted the initial loans, their position should be rather safe. Also now that you have the other three big parties more or less all intervening in the Greek Programme, it is hard to see that voters would abandon all of them…

What other factors affect negatively the Finnish economy?

Currently, our structural problems are well-known: two our strong industries, the communications sector led by Nokia and the pulp and paper sector have seen a very big structural demand reduced drastically, and our economic structures do not enable dynamic shift of resources from one sector to another. So those structures would need to be made more flexible, and at the same time the whole structure of the economy would need to be changed so that it would be more supportive of labour mobility, and adding to labour supplies needed with the ageing population. Then at the same time, the wages have been quite rigid, meaning they have been rising even though the economy has been performing badly. So our competitive position at the moment is not very strong. So those are the problems.

And then we had a government who proposed a structural reform programme that had potential, but then one after another these proposals have been abandoned, and you could say that during the final one year of its term the present government has not been able to do anything useful. And now it seems that they are going to fail in all their final attempts as well. So basically that was another year wasted, if one does not say that it was four years wasted…It has been quite pathetic, their performance, at a time when Finland would actually need reforms.

The National Coalition Party and in particular M. Stubb seems to attribute it to the fact that it was a large coalition government? What do you think?

I think that it is partly due to that it was a coalition with six political parties. But also it relied quite a lot on the leaders of the major parties who have prepared and signed an agreement initially. Then the parties whose leadership has not changed have left the government, and, among the remaining four, only one has the same leader as when the agreement was signed: but the fall took place when the National Coalition Party and the Social Democrats changed leadership, and even though they tried to keep the image of being able to work together, things have fallen apart. The commitment that was made among the previous leaders of the parties was not there any more.

On another topic, are we seeing already the impact of the sanctions against Russia?

We are, yes! The Russian economy was already slowing down before the Ukrainian situation, so the sanctions only aggravated the problems of the Russian economy. Russia used to be for Finnish export roughly at the same level as Sweden and Germany, now they are clearly smaller. We are clearly seeing those effects already, and they are not coming at a time when the Finnish economy can easily absorb it, because we did not see any growth even without the Russian developments.

What are the most affected sectors in Finland?

With the Russian crisis, I would say the pulp and paper sector is affected to some extent, then of course the groceries’ exports, these are the ones which have numerically been hit the hardest. Machinery also to some extent. Near the Eastern border, we had a lot of Russian people coming to buy stuff from retails there, but comparatively those flows have not had a huge impact.

What are the interactions in Finland between the banks and the government?

There are some interactions, but nothing which would have huge consequences. However, the banks have an excellent knowledge of what happens in the economy, and the government wants to utilise this information, so there is a dialogue, but I am not very aware of any official discussion forum.

You have written on Twitter that the government is borrowing at a negative interest rate. In Finland, there is a lot of discussions about the increase in the public deficit. Does it mean that there is an increase in the cost of the public debt?

No, not so far. The average interest cost is actually falling. However, when the debt itself is rising fast, the interests’ burden is gradually rising as well. Finland has lost of one of its AAA rating from Standard and Poor’s last year, but for the other two we still have AAA with stable outlooks. The immediate effects of the Standard and Poor’s move were quite limited. Finnish bonds felt some pressure from the Russian development last year, but they have been quite modest.

So you could say that Finland has not really suffered from the weak fiscal performance yet. Part of the reason is that the Finnish history is rather encouraging in a way: in the 90s, when there was a crisis, it was dealt with determination, the deficits were quickly cut and the debt paid. Something which is often mentioned is the consensus-based culture, even if I could question how it still applies. Internationally it is still valued. Moreover, the government debt is still at low levels compared to other countries, so there is a buffer for some weak years, but I think that the buffer is quickly being exhausted here. How long can Finland continue like this without losing markets’ confidence? Probably not many years any more.
Now, it is true that we have the big easing programme from the European Central Bank, which should benefit actually Finnish bonds more than those of many other countries. So that programme in itself should make sure that Finnish yields are not going to go higher in the next few years.

There is a consensus among the main parties in the campaign to cut in the public expenses around 2 billion euros, a figure proposed by the National Coalition party and the Centre Party. What would be the impact on the economy?

I think that the focus is gradually shifting. The present government made a big mistake: they said that you need to increase taxes as much as you cut spending, but spending cuts have been quite limited when the tax cuts were working already. For the economy that has been a very bad decision. For the 2 billion euros, if they are spread over the next term of the government, it should be manageable. Of course it would have some negative consequences for the economy, but at a time when we are spending so much more than we can afford to, it cannot be really avoided any more. When you have a cyclical recession, it makes sense to soften that via public stimulus, and take that stimulus back when the economy is doing better again. But now we have so many weak years behind already that you could easily argue that the problems that the Finland economy is facing are not primarily of a cyclical nature. There is a cyclical component as well, but it is not the major source of the problem. So you have to look at the structural balance.

You can still say that with the economy this weak, it does not make sense to implement all the cuts at the same time, but the plan to cut spending needs to be crystal clear. We are in a situation where we cannot afford to wait too much for the growth to come to the rescue any more.

For the cuts, what are the sectors which should be targeted if you want to preserve the future?

Well, I would prefer to let that decision to the politicians! From an economical point of view it is clear that the spending cuts are less harmful than tax increases. But if I should have to give some indications of what kind of reforms should be made, then I like the idea that the social security systems should be more encouraging to take jobs: you could think of reforms of the unemployment benefit system, is it too generous and it lasts for too long. It could be a better system if you get a better compensation for a shorter period of time, and then the benefits are cut if you are not finding re-employment. So basically if you have a rather good compensation for a short time, it would allow you to really search more vigorously for a new employment, as it seems that the chances are best rather early. So without saying in the details about where one should cut, I would try to focus the cuts in areas where you can make the system more encouraging.

What kind of advice do you give these days to investors?

Without going into the specifics, you can find quite many opportunities in the markets, but I guess the bottom line is that we are not going to see noticeably higher interest rates for a long time, especially in Europe. In the USA, you have some potential for them to rise, but after the latest ECB measures, it will not happen that strongly in Europe.

Does it mean that people should invest in shares?

That is something we have seen for many years already, and as long as interest rates stay at this level, that is not going to change. Having said that, we have not really seen a big bout of selling of shares either for quite some time. So I would still expect that the volatility is going to increase somewhat.

Now we have some worries about Greece, about Ukraine, but then in the bigger picture, things should calm down eventually, probably in the second half of this year at the latest, because then we have the impact of the ongoing ECB actions. I think that there is a good chance that we will see the Euro area economy surprising to the upside this year. And then assuming that these crisis which are ongoing are subsiding at least to some extent, there is some room for a positive surprise on that horizon. For the longer term, we need some good decisions on the part of the Euro governments as well. And those are still lacking to a large extent.

You seem to imply that there are good news coming from the US?
There are, yes. I think that one component which has been lacking in the US recovery has been rising wages, and those pressures are gradually starting to emerge as well. We are still seeing modest wage gains, but that is gradually changing and this missing component can finally trigger interest rates increases from the Federal Reserve.

Would you like to add something?
We have had an extensive discussion, but I would like to emphasize the fact that now, there are actually many ingredients for positive surprises for this year in the Euro area, but in the longer term one should not assume that this is the start of a long and endless recovery, unless we see the Euro area governments take action to remove some of the obstacles for longer term growth, such as the rigidities in the labour market. This applies to Finland, and applies also to most of the Euro countries. These decisions need to be taken, but unfortunately there is not so much pressure to really implement them at the moment.

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