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Political Economy Complicates Greece

NEW YORK ( BBH FX Strategy) -- Greece's economic mess has understandably dominated investors' concerns. News from the European Central Bank earlier Wednesday that Greek bank deposits fell 2.7% in February and now stand at the lowest level since October 2006 reflects the ongoing bank run. The fact that Greece's new 10-year bond is yielding around 20% reflects ongoing concerns that the Private Sector Initiative has not put closure on this chapter of Greece's tragedy.

The International Monetary Fund's mission to Greece warns that the pace of reforms remains insufficient and it highlighted the efforts to fight tax evasion to underscore its conclusion that "the rescue has a high risk of going awry."

Note that the Troika is in Athens Monday and is pressing Greece for another 11.6 billion euros in savings for the 2013-to-2014 period. This will give the new government little breathing room.

Although there has been no official announcement, the local press appears to be thinking that a May 6 election date is most likely. Polls suggest that a terribly fragmented parliament will result. The largest party is the New Democracy is polling around 20% presently -- that may translate into 60 seats in the 300-seat parliament. The lack of a strong government does not bode well for decisive action or painful structural reforms.

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One area that we have pointed to previously that offers scope for savings yet to be fully explored and that does not further squeeze employees and pensioners is defense spending. Even though Greece has trimmed its military spending, it is still highest in the region.

If, over the past decade Greece would have spent only the eurozone average of 1.7% of GDP on defense, rather than 4%, it would have saved a little more than 50% of GDP or roughly 150 billion euros -- more than the second aid package.

Greece argues that its needs to strong defense spending for two threats. The first is from Turkey. Yet relations have improved and a military confrontation between these two NATO members seems quite remote. The other threat Greece is thought to face is refugees from Northern Africa and Middle East. Yet the kind of weapons Greece buys, like submarines and fighter jets, do not seem suitable for border protection.

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