Samvat 2068 - Tighten Your Seat Belts - Turbulence Ahead.

It has been a very long time since I wrote about the economy and markets. To be precise, my last blog was in August 2010. How the world has changed in one year! My last blog was very optimistic. There was a sense of expectancy and excitement about Dr. Manmohan Singh's Government. They say that a week is a very long time in politics. So, it is not surprising that in one year euphoria has given way to despondency.

The intention of writing this blog is to assess the economic and market conditions prevailing in the country as well as globally and to understand its implications on an average investor such as you and I. In my reckoning, the global economy is in a condition that is worse than in 2008. Last financial crisis was sudden - an accident - an emergency and so it got immediate treatment. This crisis is slow - evolving -  changing everyday. It is like a cancer. Everybody knows that it will end up really badly but no one has a cure.

Europe is in a mess. Forget the leverage problem, to me the most fundamental problem with Europe is that the economic growth of the continent is not consistent with the life-style and the benefits that the Europeans have got so used to. Also, the demographics are not in Europe's favour. The number of working people as a proportion of total population is declining. It means that less and less people have to work to support more and more. (See http://www.monitoringris.org/documents/tools_reg/agingdemochange.pdf). I am of the  opinion that the ongoing crisis in Europe will be the trigger that will push the continent into an extremely long period of very low to negative growth.

USA has the capability to surprise the skeptics by delivering decent growth. Unlike Europe, USA does not need to worry about demographic ageing till 2050 and it has a very dynamic society which thrives on enterprise and innovation. However, in democracies bad politics often trounces good economics and that is a real danger for USA as it approaches an election year. Although the real economy is not in a terrible shape, the American Financial System does have a tendency of getting out of hand and severely damaging the real economy (Remember 2008 - financial crisis triggering economic recession). Thus, risks to American economy remain and it is likely that growth will be positive but very low.

Japan is trapped in an unending cycle of almost zero growth and almost zero inflation. The population is already ageing and it seems that the economic stagnation will continue for the foreseeable future. China is growing but slowing down. In the last two decades, China managed enormous growth by selling goods to Europe and USA. China is a country with enormous savings while Europe and USA had very limited savings. So, what China did was that it happily provided its excess savings to Europe & USA so that they could buy more and more of Chinese goods. It was just like an Electronics Store offering cheap loans to its customers to increase the sales. This model worked wonderfully till 2008. But now, China's biggest customers - USA & Europe are slowing down and China is bound to feel the heat as its economy is primarily export driven. Also, after 2015 Chinese working age population will start to decline and this will also have a negative effect on economic growth.

In contrast to the global economy, the Indian economy is in a reasonably good shape. This year the GDP is expected to grow at a rate of 7.5% to 8.0% which is healthy. However, the problem is that given our level of under-development, any growth rate less than 9% is an under-achievement. Another issue is that by global standards, the Indian economy is quite insignificant. Indian GDP makes up less than 3% of world GDP (See http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)). Hence, until we grow at a rapid pace for atleast next 5-10 years, we will continue to remain a marginal economic power. But to achieve truly rapid growth, we need a proactive and business-minded government which is certainly not the case at this point in time.

In view of the above economic scenario, I can not imagine that Indian equities will give a phenomenal return in the next one year. If Europe, USA & Japan are not growing much and China is slowing down, then it is hard to see how the stock-markets can perform well. If the central banks print more money to tackle financial crisis (QE 3), then there might be a temporary pop in the stock markets, but it will be short-lived. In the coming year, my investments will be guided by the following principles -

• If you already own stocks, stay invested and do not put more money in stock market.
• If you do not own stocks, stay out of the market till the time there is a major upmove (say sensex crossing 20,000 mark).
• In India, interest rates are at an all time high, so use it to your benefit. Invest in PSU Bank FD's at 9.25%. Some co-operative banks offer around 10%. One can also look at FD's or Debentures offered by top rated companies. This can fetch you returns of around 11% which is quite good.
• Invest some amount in Gold. If central banks print too much money, it will inevitably lead to high inflation. Gold gives very good returns in periods of high inflation.
• The next year will witness extreme volatility and your sources of income (jobs and businesses) can get impacted. Hence, be conservative in your spending and avoid taking unnecessary risks.

India's time as a great economic power will definitely come. But it will take atleast ten to fifteen years depending on what kind of political leadership we get. As India emerges as an economic powerhouse, our investments must also deliver fantastic returns. However, that prospect will materialize only in decades and not in years. In the short-term, we must make the necessary adjustments to our investment patterns as the situation demands. Someone has rightly said "We can prosper in the long term only if we can survive in the short term". It is my humble opinion that Samvat 2068 is going to be more about survival than prosperity. So be cautious.

Mutual funds - not so good.

It is difficult to figure out why small investors should put their money in mutual funds. But millions of them across the world, including in India, do. The logic for such investing is simple and appealing. I, the lay investor, have neither the resources nor the ability to track individual equities. So, I will put my savings in the hands of experts who will do the job for me, at a price.


(For the purpose of this discussion, we will stick to investment in equity-focused schemes which are popular with retail investors, and not go into debt- and sector-focused schemes in which firms and experts dabble.)

Trusting the expert is fine but how do you pick your expert — the particular scheme of a fund in which to put some or most of your savings? In India, there are no more than 500 actively traded shares of firms of any consequence. There are mid- and small-cap firms, with and without promise, not to speak of technology startups, the successful among which can make an aggressive investor a millionaire. But they are not for the risk-averse small investor. All she wants is returns which are several percentage points higher than what bank fixed deposits will pay — and this is important — the ups and downs averaging over a period.

There are now over 3,000 schemes, five times the number of established, visible companies. Well-known firms are touchy-feely things. You see their presence — factories, offices, employees, products — everywhere. But a fund house in comparison is a faceless post box, or a few floors in a financial sector office block.

A mutual fund buff will tell you that a little bit of research will enable you to select a few well-performing schemes and you are guided in this by the extensive disclosures and mountains of research and rankings that swamp the financial media. But if you have the gumption to research mutual funds, then you can research stocks too, and good ones are not cheap (nothing good is) but easy to pick. Most small investors have till now chosen schemes recommended by a commission-earning agent or a friendly adviser at your friendly bank who herself and her bank earned a fee on selling the product to you. Significantly, mutual fund sales have plummeted ever since Sebi, the capital market regulator, stopped charging the investor a fee for the selling agent.

After the quite unscientific selection on the basis of advice from commission-earning agents, the small investor’s problem is not over. How long does he stick to a scheme? Is there a case for churning your investment once in a while, not too often though, to take advantage of new, attractive options, which again agents have been more than happy to recommend? If your investment is doing well, then the urge to churn is low.

But what if it is not? And, what if the fund management professional who was a bit of an industry acknowledged whiz-kid has moved? Typically, fund management professionals change more often than company managements. The latter happens when there is a succession or a merger or acquisition deal involving the company. Even otherwise, a CEO change in a firm is less discontinuous for it than a fund manager change in a mutual fund.

Now let’s come to the returns that fund schemes bring. All funds taken together seldom outperform the market. If they did, the choice would be easy: invest in a fund of index funds.

Here again, there is a catch. An index fund is not really on autopilot. Stocks that make up an index change over time. By the time a stock drops out of an index, interest and activity in it and its valuation have usually waned. After the exit, the stock can go through the same process a bit more. A well-managed index fund will go light on a stock before it is dropped from the index.

The cardinal argument in favour of mutual fund schemes is that there are any number of them which outperform the market. They do. But it is more difficult to pick them than to pick a few good stocks. An additional plus point in favour of picking a scheme is that in the process you select an entire portfolio, which spreads your risk. If you have to pick your own stocks, then you have to pick several.

The key to sensible investing is to know your own preferences. If you are totally risk averse, go for bank fixed deposits. If you have a longer time frame, six years or more, then go for the public provident fund. If you can stay invested for over six years and agree to take on a small risk, then go for equities.

Make a list of say 20 best-known companies which are considered to be alive and kicking. Make sure that the list has both firms whose products are widely used and popular, like Maruti Suzuki, and firms with a strong physical presence (plants and townships) like Tata Steel and NTPC; don’t end up with over-representation in one sector (too many software shares); then divide up your investment funds into five and make your investment at six-month intervals over a two-year period. Thereafter, forget about it for five years. My sense is that when year seven dawns, your portfolio will have a distinctly better chance of giving you a handsome return than going the mutual fund route.

(R)evolution !!!

It has been quite some time since I wrote about our country and its economy. Right now, it is raining heavily here (Ahmedabad) and I have things to do which can wait. So, let me do a round up of things that have happened in India during last six months.

The thing about Dr. Manmohan Singh's current government is that it is making path-breaking changes in the country. In a sense, it is almost a revolution. However, democracies are generally not very amenable to revolutions. In democracies, and particularly ours, things "have to" change slowly - almost imperceptibly. It seems that given the fractured nature of our polity, things can change given that you change them slowly and cleverly enough. And this is what Dr. Singh has mastered. He is making a revolution look and feel like evolution - gradual, unthreatening and irreversible.

Consider the recent deregulation of petrol prices. With diesel prices also set to be deregulated, this constitutes one of the biggest and boldest reforms in the last decade. What is most note-worthy is that even the “aam admi” recognizes the need for reforms. To be sure, there was a hue-and-cry by the opposition and a strike after the petroleum hike. But it all fizzled out very quickly indeed. Also, the government has made significant changes in the fertilizer policy during the last six months. Such policy initiatives will definitely reduce the subsidy burden and will help the country reduce its deficit. The recent Greek crisis abundantly demonstrates the perils of high deficits resulting from populist policies.

Goods and Services Tax (GST) is all set to become a reality from 1 April 2011. The finance minister is determined to implement GST from the next fiscal. In the recent meeting between the finance minister and the states, a broad consensus has been reached about GST rates and its implementation. This, along with the adoption of a new Direct Tax Code (DTC)

will be of enormous help to the country in the long run. With introduction of GST, the long cherished goal of India becoming a huge seamless market with uniform taxation will be accomplished in a period of 2 to 3 years. Also, with such tax reforms the cost of compliance for the tax-payer will decrease and it should lead to an increase of Tax-to-GDP ratio of our country.

On the social sector front, initiatives like NREGS are having a real impact on rural India. Places like Surat are facing acute shortage of labourers. The reason is that earlier rural poor people from states like Orissa and Bihar provided abundant cheap labour. But with NREGS, such people are getting employment at good wages and are opting to stay back in their villages. Even FMCG companies are finding out that the purchasing power in rural parts of the country is increasing. In the coming years, the game changer is going to be the UID project that the government has launched. With Mr. Nandan Nilekani heading this project, I am very optimistic about its implementation. If this project is even 50% successful, it will change India for ever. The success of this project will have far-reaching positive implications for areas such as security, public distribution system, tax administration, health care and many more.

As far as the investment climate is concerned, the primary market has revived owing to a return of risk appetite among investors and a supply of good quality issues in the recent weeks. Recent IPOs like Engineers India Ltd. and SKS Microfinance have done well. The government has announced an ambitious disinvestment plan and it will mean that there will be steady supply of IPOs from quality PSUs. The recent regulatory changes made by SEBI in areas of mutual funds (ban on entry load) and M&A (new take-over code) will serve the average investor very well. The government’s intentions of allowing FDI into retail sector and decontrolling sugar sector have added to the positive sentiment on Dalal street.

In the area of infrastructure, at long last some real progress is visible. The swanky new terminal (T3) at New Delhi’s airport is an example of how well a public-private partnership can work in building world-class infrastructure. It also seems that under Mr. Kamal Nath, the highway construction programme is gaining momentum. In states like Gujarat, a big push is being given to port-building and ship-building. Urban infrastructure is slowly improving because the local civic authorities are being pressurized to match up to the growth that the cities are witnessing.

In spite of an erratic start, the monsoon has progressed well this year. With this, the recent spurt in food inflation should ease out. A good monsoon will also mean a healthy rural demand. As per RBI’s most recent projection, the economy should grow by 8.5% in 2010-11. I am tempted to opine that GDP growth rate will be closer to 9.0%. With this kind of growth, India will be a very fertile ground for new ideas, new products and new enterprises. New wealth will be created. As usual, the private sector will take the lead but unlike past, even the government and the public sector might surprise us pleasantly!

- Mikin Shah
  foresight school

GCET 2010 and beyond!

Now that the merit list for GCET 2010 is out, it would be proper to reflect upon the test that was unique in its format, duration and delivery. With a total duration of 80 minutes, this year’s test was by far the shortest as compared to any other MBA entrance exams in India. Also, what really mattered were the first 64 minutes wherein the candidates had to answer 80 questions of quantitative ability, verbal ability and logical reasoning. Thus GCET 2010 closely resembled T20 cricket – quick, intense and unforgiving!

With a shortened time-span, the candidates had to be at the top of their game right from the first click. Many students found that it was almost impossible to recover from a poor start because of the short time duration. The only saving grace was that two attempts were available for each candidate. Given that a good start was critical in GCET 2010, it would have made sense for students to first attempt questions that were from an area of their strength. In my case, verbal ability has been an area of strength and I have always started by answering questions from this area. In fact in all the GCETs that I have taken, irrespective of the format and duration, I have always stuck to my attempt pattern of Verbal followed by Quant followed by DI/DS followed by Reasoning.

It is important to note that compared to earlier GCETs, GCET 2010 has laid a greater emphasis on reasoning while the proportion of verbal ability questions has been reduced. Within verbal ability, there were very few questions pertaining to vocabulary and comprehension, while basic grammar was given greater importance. I have observed that many students from Gujarat dread the verbal section because of their perceived discomfort with the English language. I believe that the solution to this problem is two-fold. The first part is that the student must convince herself that she can be good with the English language. The second part is that the student must form a good reading habit. Improving verbal skills requires a long-term effort and it cannot be sustained unless proper habits are formed. Personally, I cannot start my day without going through a newspaper and I enjoy listening to cricket commentary by likes of Harsha Bhogle and Tony Greig. Such simple things go a long way in improving students’ comprehension, vocabulary and general language skills.

In the quantitative section, basic arithmetic was very well represented and students did not face too many difficulties solving these questions. Although questions related to permutations, combinations or probability were not asked, a high number of trigonometry questions were asked this time. Even during last year, trigonometry was given a fair weightage. Hence, students preparing for future GCETs would do well to concentrate on trigonometry (including height and distance). In the quantitative section, there are always questions which do not require to be solved. One can easily answer such questions by simply plugging the alternatives. For example, problems pertaining to divisibility, ages, work and time etc. can easily be solved by using the options. In GCET 2010 as well as GCET 2009, one could have easily found at least 2 to 3 such questions. The key is to identify such questions and this ability comes with practice. The big surprise in GCET 2010 was that not a single question was asked from areas of data interpretation and data sufficiency. The key to data sufficiency is conceptual clarity while data interpretation requires comprehension and an ability to perform calculations quickly. Students preparing for GCET 2011 would be well advised not to ignore these areas.

The reasoning section in GCET 2010 was all about variety. The 30 reasoning questions covered a very wide range of topics such as syllogisms, family relationships, symbol based questions, alphabetical coding, directions, verbal reasoning and many more. Students would have done well to avoid the puzzle type questions because here the data set was followed by only one question! General knowledge section (section II) was a game changer because students had ample time to attempt all the 20 questions if they wished to. A large number of questions were related to current affairs. This highlights the need for students to be abreast of contemporary issues and developments.

Since the test was conducted in an online format, it was crucial that the students had a very good idea about how the test “looked and felt”. Familiarity with a mouse was not enough. What was really needed was a first-hand idea about the way the test screen appeared, the manner in which icons were displayed, the way in which instructions appeared etc. Hence, those students who had taken an online mock test before the real thing had a better chance of scoring well.

Looking ahead, GCET 2011 may make a few changes to the test but the online format is here to stay. Also, given the keenness of the authorities to offer multiple attempts, I do not expect the future GCETs to be any longer than this one. In my opinion, to excel at GCET, a student must:

• Give himself at least 6 months of preparation under an experienced mentor.
• Develop good habits and focus on conceptual clarity rather than ready-made formulae and short-cuts.
• Thoroughly know her strengths and weaknesses and accordingly formulate a plan for attempting questions.
• Be fully conversant with the online format and take a sufficient number of online mock tests.

- Mikin Shah

About the Author : Mikin Shah is ranked 1st in GCET 2010 (MBA). He was also ranked 1st in GCET (MBA) 2004 & 2009. He is a co-founder of foresight school: A GCET Prep Institute.

The answer to your problems - Entrepreneurship.

Are you ready for it ???

A recent piece on the impending glut of MBAs in India apparently struck a chord with many who have recently graduated with an MBA degree and are still looking for a suitable job. While a few chose to remain in a state of denial, some others want to know what their options could be. The good news is that India offers extraordinary opportunities for those who are reasonably well educated and are enterprising.

There are many things going on in India for the enterprising and the determined. To start with, the country’s economy is not only one of the fastest-growing ones in the world, but at about $1.37 trillion in 2010, it is already one of the top-10 in the world. It is expected to grow at 8 per cent or more for many years to come and hence, by the end of the next decade, it could well double from the current size in real terms, making it one of the top-five or six in the world. Further, and very fortunately, India’s growth is coming from both services and manufacturing sectors. While agriculture is lagging behind, there is every reason to believe that even agriculture/food and food processing sectors will see significant growth in the coming years. Further, with India poised to spend upwards of $500 billion in infrastructure alone in the next five-seven years, the country’s growth will be reasonably well-spread geographically since new power plants, roads, ports, airports and new urban centres will be established all across India creating new hot spots of economic activity in just about every region. And finally, India’s economic growth has been reasonably equitable. While there are many hundreds of millions still below the poverty line, it is also true that more than 250 million have been pulled out of the poverty trap during the last 20 years, thereby creating a broad-based, strong and sustainable private consumption story with more than 500 million middle- and upper-income consumers of all kinds of goods and services.


Notwithstanding the many challenges that India currently faces — endemic corruption, creaking infrastructure, runaway real estate prices and, in some parts of the country, internal security and law and order issues — in this very fertile economic environment, there are countless opportunities for entrepreneurs in just about every area of private consumption and public investment. Contrary to popular perception and preference, such entrepreneurial opportunities do not exist only in technology/Internet domains. They range from as basic as affordable and good quality/well-served fast food such as that pioneered by Ray Croc at Macdonald’s and personal care and grooming products and services such as those pioneered by Estee Lauder (or even a Vinita Jain of Biotique, and Mira Kulkarni of Forest Essentials, affordable clothing such as Donald & Doris Fisher’s Gap and Ortega’s Zara, and Kamprad’s affordable furniture chain IKEA) to the thousands of not-so-glamorous but equally promising ventures relating to urban or industrial waste management, vocational training, professional security services etc. etc. etc.

The legions of newly minted MBAs (and engineers and even graduates with basic non-professional degrees) should seriously contemplate starting up simple but innovative entrepreneurial ventures. Almost all successful entrepreneurs, including those who made it to the ranks of billionaires and globally iconic tycoons, started with something exceptionally basic and really small — a first shop, a first restaurant, a first range of products sold at a sales counter of a retail outlet, a first training “shop”, a first pick-up truck for moving merchandise or even collecting and moving waste etc. And many of them did not necessarily start from New York or London or Mumbai or Delhi. In a geographically large country like India, while the top six-eight metros certainly offer many more opportunities, the cost and competition there are also more intense. Hence, the prospective young entrepreneurs should untether themselves from the comfort of their own family homes or the allure of the more glamorous mega-cities and reach out to smaller towns and even rural India to build their fortune. Indeed, generations ago, the pioneers ventured out on the high seas to unknown lands and continents, and many of them successfully spotted entrepreneurial opportunities there.

Hence, dreaming entrepreneurially and then thinking and starting small (even if ambition is big), differently, and innovatively may be more productive than polishing up CVs and waiting for that interview call!

MainBhiA

A dose of realism ! A must read for all MBA students....

For the last few years, every MBA placement season sees a flurry of releases from various business schools on the highest and average salaries offered to their newly minted MBA graduates. Each year, the numbers show a rising trend, and if these numbers are to be taken at face value, India must be facing an incredible crunch of entry-level managerial talent since such compensation levels are aspirational even for mid-career professionals in other functions, such as manufacturing, or professional service providers, such as doctors and chartered accountants. Sometime later in the year, it would be the “ranking” season when leading business magazines come out with cover stories carrying their rankings of leading business schools in India, adding further glamour to the MBA degree.


Largely unstated are the less-than-stellar overall placement records for most MBA institutes in India, including some that have made it to even the top-10 rankings. While it may be true that finally most MBAs from the top-10 or even the top-25 ranked institutes find some job and hence they are technically “placed”, it is also true that increasingly, many of them are forced to take up jobs that could be easily managed by someone with a basic graduation degree itself. The plight of those who do not come from the top-25 institutions is probably worse. Indeed, if the glamour and the clamour for an MBA degree continue to grow as it has in the last few years, and with both public and private institutions creating capacity at the same pace as they have been doing recently, it may be an exaggeration, but just barely, that we will see legions of MBAs in the field sales force of pharmaceutical or FMCG companies, on the shop floor of retail outlets, and in different types of BPOs and KPOs.

Hard data supports the onset of this glut of MBAs. In 2000, there were about 600 colleges in India offering about 70,000 MBA seats. By the end of 2009, the number had increased to 1,400 colleges offering about 120,000 MBA seats! The intake of the top-20 institutes alone has increased from 1,500 in 2000 to over 5,000 in 2009, and is poised to increase further in the next five years as more IIMs come into operation while the current top-ranked ones (IIMs and others) further expand capacity or add new campuses and programmes. By comparison, the US (whose economy is over 10 times bigger than that of India) has about 1,000 colleges offering about 150,000 MBA seats to both US citizens and to a growing pool of international applicants. In the entire European Union (EU), whose economy is also over 10 times that of India and which has much more diversity in terms of number of countries and businesses, there are just about 550 colleges offering about 100,000 MBA seats. Major EU economies such as Germany, France and the UK individually offer between 8,600 and 27,000 MBA seats despite each being significantly larger and more global than India is at this time.

Making it worse is the highly flawed selection criterion of almost all Indian MBA colleges, including the IIMs. The 2010 incoming batch, for instance, has just 6 per cent women, about 94 per cent are engineers with just an isolated representative from arts stream, 33 per cent have no work experience at all and 41 per cent have less than two years of experience. There is very high probability that even this experience profile will largely have applicants who have worked in the IT sector post-engineering and wish to make a transition out of the IT sector itself. Harvard’s class of 2010 has 38 per cent women, just 32 per cent are engineers, and over 84 per cent have experience of more than two years. ESADE (Barcelona, Spain) has 48 nationalities represented in its class of 180 students with an average work experience of seven years.

Hence, we not only have an oversupply of MBAs already, but have MBAs whose academic and experience profile actually makes them another “brick in the wall”. There are no easy solutions except that MBA colleges have to reinvent themselves and their programmes immediately before they add more capacity, and all new aspirants for an MBA programme should keep in mind that an MBA degree from even a high-ranking institute may not translate into a dream job in the near future!

Greek Tragedy

An Insightful article on the Greek Sovereign Default Crisis.

Greece will default on its national debt. That default will be due, in large part, to its membership of the European Monetary Union. If it were not part of the euro system, Greece might not have gotten into its current predicament and, even if it had gotten into its current predicament, it could have avoided the need to default.

Greece’s default on its national debt need not mean an explicit refusal to make principal and interest payments when they come due. More likely would be an IMF-organised restructuring of the existing debt, swapping new bonds with lower principal and interest for existing bonds. Or, it could be a “soft default” in which Greece unilaterally services its existing debt with new debt rather than paying in cash. But, whatever form the default takes, the current owners of Greek debt will get less than the full amount that they are now owed.

The only way that Greece could avoid a default would be by cutting its future annual budget deficits to a level that foreign and domestic investors would be willing to finance on a voluntary basis. At a minimum, that would mean reducing the deficit to a level that stops the rise in the debt-to-GDP ratio.

To achieve that, the current deficit of 14 per cent of GDP would have to fall to 5 per cent of GDP or less. But to bring the debt-to-GDP ratio to the 60 per cent level prescribed by the Maastricht Treaty would require reducing the annual budget deficit to just 3 per cent of GDP — the goal that the eurozone’s finance ministers have said Greece must achieve by 2012.

Reducing the budget deficit by 10 per cent of GDP would mean an enormous cut in government spending, or a dramatic rise in tax revenue — or, more likely, both. Quite apart from the political difficulty of achieving this would be the very serious adverse effect on aggregate domestic demand and, therefore, on production and employment. Greece’s unemployment rate is already 10 per cent, and its GDP is already expected to fall at an annual rate of more than 4 per cent, pushing joblessness even higher.

Depressing economic activity further through higher taxes and reduced government spending would cause offsetting reductions in tax revenue and offsetting increases in transfer payments to the unemployed. So, every planned euro of deficit reduction delivers less than a euro of actual deficit reduction. That means that planned tax increases and cuts in basic government spending would have to be even larger than 10 per cent of GDP in order to achieve a 3 per cent-of-GDP budget deficit.

There simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline: Greece’s default on its debt is inevitable.

Greece might have been able to avoid that outcome if it were not in the eurozone. If Greece still had its own currency, the authorities could devalue it while tightening fiscal policy. A devalued currency would increase exports and cause Greek households and firms to substitute domestic products for imported goods. The increased demand for Greek goods and services would raise Greece’s GDP, increasing tax revenue and reducing transfer payments. In short, fiscal consolidation would be both easier and less painful if Greece had its own monetary policy.

Greece’s membership in the eurozone was also a principal cause of its current large budget deficit. Because Greece has not had its own currency for more than a decade now, there has been no market signal to warn Greece that its debt was growing unacceptably large.

If Greece had remained outside the eurozone and retained the drachma, the large increased supply of Greek bonds would cause the drachma to decline and the interest rate on the bonds to rise. But, because Greek euro bonds were regarded as a close substitute for other countries’ euro bonds, the interest rate on Greek bonds did not rise as Greece increased its borrowing — until the market began to fear a possible default.

The substantial surge in the interest rate on Greek bonds relative to German bonds in the past few weeks shows that the market now regards such a default as increasingly likely. The combination of credits from the other eurozone countries and lending by the IMF may provide enough liquidity to stave off default for a while. In exchange for this liquidity support, Greece will be forced to accept painful fiscal tightening and falling GDP.

In the end, Greece, the eurozone’s other members, and Greece’s creditors will have to accept that the country is insolvent and cannot service its existing debt. At that point, Greece will default.