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The Sword over Greece

In trying to buy time in the count-down to the restructuring, European leaders are playing with fire

The prospect of a restructuring is hanging over Greece like a Sword of Damocles. The country’s public debt is expected to exceed 150% of GDP this year, a ratio which was initially predicted for 2014, and it should reach 166% of GDP in 2012 (Eurostat). Besides, Greece is the only country among the group of ailing economies in the euro area (the so-called PIIGS, namely Portugal, Ireland, Italy, Greece and Spain) that needs to generate an unrealistic primary surplus over the next few years in order to stabilise its public debt-to-GDP ratio. Despite the “significant progress” made in the area of fiscal consolidation during the first year of the adjustment program, as stated in the IMF’s 4th Review Mission, this means that forthcoming budgetary targets are unlikely to be met.

This scenario is unlikely to change with the new austerity program approved by the Greek Parliament. This medium-term fiscal strategy (expected to yield €26bn worth of savings over 2011-15) combined with a privatisation program (€50bn by 2015) should bring the country’s public deficit below 3% of GDP by 2014. This objective is overly ambitious. Austerity measures in the form of job cuts in the public sector and lower wages will undermine the government’s ability to raise revenues from taxes, making it difficult to generate the required primary surplus. In fact, the European Commission has already revised down its primary balance forecast for 2012 by 1.5 pp to -1.8% of GDP in May.

An obvious question is then why, if a restructuring is the only way to stabilise public debt dynamics in Greece, is the “Troika” (European Commission, IMF and ECB) choosing to postpone the redemption date?

The main reason is that they are hoping to avoid the risk of contagion to other fragile Member States. By buying time, they anticipate that the fiscal and economic situation in other “periphery” countries will improve and that the new adjustment program in Greece will yield a first series of optimistic results that will ease market pressure.

Fears of contagion are warranted for any restructuring will undoubtedly have significant adverse effects on the Greek economy and beyond its frontiers through trade and financial linkages. However, since no realistic effort of deficit reduction would suffice to stabilise the debt ratio, restructuring is a necessary evil. The question is therefore one of timing. An orderly restructuring, which would involve thorny negotiations, could still be designed in a timely fashion with the support of the IMF. This would subsequently raise the chances for Greece of going back to the markets while allowing a swift economic recovery by partially relaxing fiscal and policy constraints. By contrast, a messy restructuring, one that would come too early or too late, could block access to private funding for years and amplify adverse effects on the economy.

But we are not there yet. European policymakers and IMF rescue teams are looking to expand their financial support to Greece while trying to secure voluntary participation of private creditors in the form of a debt roll-over (known as the “Vienna initiative” in reference to the coordinated decision of EU-based cross-border bank groups not to withdraw their capital from emerging Europe at the height of the financial crisis). This joint commitment to stave off a needed debt restructuring will only compound the ultimate costs of such a restructuring. It is also bound to make private sector involvement unconvincing, since it is equivalent to asking them to take the risk of suffering a greater hair cut later on.

A second bail-out looks indeed necessary to cover Greece’s borrowing requirements since it unlikely to be able to go back to the markets in 2012 as initially planned. Just like during the Argentinean debt crisis of 2001-02, the IMF (with the EU today) are yielding to market pressures to continue providing financial support despite Greece’s proven insolvency. An IMF paper (2004) attempting to draw some lessons from the experience of Argentina, recognises that this is a mistake: “the limits to the Fund’s involvement should be based on the underlying quality of policies, not on the perceived costs of withdrawing support”.

Today the likelihood of success of current fiscal consolidation policies is near zero. Austerity measures imposed on Greece in exchange for EU/IMF financial support hold the risk of being counterproductive. As argued in a recent report by the UN (22 June), these policies are contributing to a more uncertain and fragile economic recovery essentially by limiting fiscal and policy space. There are also some political and social limits to raising taxes in the context of a recession and considering the extent of popular discontent at present. These measures also seem to forget that regaining market confidence involves building up the bases for promising economic growth.

The IMF and European policymakers are claiming that national ownership of fiscal adjustment programs is key to their successful implementation and insist that additional lending to Greece should hinge on a clear commitment from both the government and Parliament. But this is in no way a guarantee of credibility for the future, especially when considering Greece’s poor fiscal track record. In fact, national ownership in the current context –under significant market pressure– is illusory.

In Portugal, there is a clear sentiment among the population that the elected candidate at the snap elections which took place on June 5 has been imposed to them. They had no other choice than to vote for the leader of the opposition party which committed to implement the IMF/EU adjustment program that would secure financial aid. In Greece, the confidence vote was essentially meant to reassure financial markets. No alternatives were presented to citizens: an exit from the euro area is simply unthinkable, and there has been no attempt to bring together all stakeholders to discuss a potential restructuring.

A year after the IMF and the European Union first rallied to rescue Greece and in a context of ongoing uncertainty, two main ideas have emerged recently which represent a starting point for getting Greece out of its (otherwise) never-ending fiscal problem.

The first is that an orderly debt restructuring should be part of the policy package to restore fiscal and economic sustainability. The Troika should be starting negotiations now, taking into account all stakeholders. The IMF has an important role to play in designing such a restructuring because the elaboration of a sovereign debt restructuring mechanism has been the object of substantial research following Argentina’s messy experience. While continuing to provide funds in exchange for adjustment policies that are doomed to fail would undermine the credibility of the Fund, offering some advice and playing the role of a mediator in the discussions for setting up an orderly restructuring of the Greek debt would instead endorse its legitimacy.

The second thought is that loan conditionality should be counterbalanced with long-term investments to give Greece some oxygen for the recovery to materialize while creating the basis for durable economic growth. In fact, the European Commission has recently suggested speeding up the disbursement of structural funds to Greece to this aim. By reinforcing technical assistance, it hopes to make sure that they are used efficiently. Out of the €20.3bn to be granted between 2007 and 2013, Greece has already received €4.9bn. This leaves €15.3bn to invest in key sectors that will boost the country’s competitiveness and overall resilience to future shocks. Greece may finally begin to see the light at the end of the tunnel.

by Morgane Lapeyre