Papandreou now has an even higher mountain to climb

THE EUROPEAN Union/IMF rescue plan for Greece assumes the country will be excluded from debt markets for some 18 months, say European Commission sources.

Greece’s sponsors hope, however, that the country gradually regains the confidence of private investors by executing an austerity plan of unmatched ambition.

“Once implemented, it will be a different country,” said a senior official who was involved in talks.

Yet the true scale of the test Athens faces is now clear. Rescue aid is tied to a requirement to cut the budget deficit by 6.5 per cent of gross domestic product (GDP) this year, an enormous commitment and one made against the backdrop of serious industrial unrest over prior cuts.

No country in modern times has managed to achieve such a cut without devaluing its currency.

“Denmark in the early 1980s, with an exchange rate adjustment,” said another official when asked if there was any comparable case.

If this greatly increases pressure on prime minister George Papandreou and his beleaguered ministers, they are heavily incentivised to achieve the cuts because they will not be able to draw down loans if they miss targets.

For as long as targets are met, the money will be available in monthly tranches according to Greece’s needs.

It will fall to euro group finance ministers to release the money each month based on a quarterly assessment of the country’s fiscal performance by the commission, the European Central Bank and the IMF.

If a lending country wavers, deciding not to provide aid, it cannot be forced to change stance. Neither can one minister block the release of funds from other countries. Were Germany or one of the other large donors to withdraw, however, the consequences could be devastating.

Still, the basic principle behind the plan is that Greece is compelled to deliver the cuts because the alternative is to return to markets at ruinous rates. This brings with it the threat of default, the very threat that led to the rescue in the first instance.

With financial reviews every 12 weeks or so, the plan is designed to provide an early warning of any deviation from the course.

Yet even while officials say fiscal monitoring will be “much more aggressive” than in the past, the prescribed cut for this year is still fully 2.5 percentage points higher than the European authorities sought from Greece only weeks ago.

This reflects the worsening macroeconomic environment and the fact that its budget deficit last year was higher than forecast at some 13.6 per cent.

The upward revision by Eurostat, the European Commission’s statistical body, essentially means that rescue starts at a different point.

In short, Papandreou now has a higher mountain to climb. For the weakest in Greek society, the pain will be all the greater.

Commission officials say Athens needs to raise €150 billion in the next three years to keep the Greek state afloat, some €40 billion more than promised under the rescue fund agreed by the euro group and the IMF.

The fund is limited, however, because the authorities expect Greece to start its gradual return to the markets late in 2011. The plan assumes the country would have regained some confidence in the markets thanks to dividends yielded from the austerity programme.

“Credibility comes from implementing the programme...In the beginning there’s no access to the market because there’s no credibility,” the second official says.

This is in keeping with the prior record of countries helped by the IMF. Indeed, European sources say they do not expect Greece will have to draw down the entire fund because the prevailing interest rates in the market should respond in kind to a drastic cut in the deficit. The budget cuts would continue, however, even after the country’s return to the markets.

By the same token, sources accepted that credit rating agencies and banks will not change their basic assessment of Greece’s position without verifiable progress. “I do not expect them to respond very favourably tomorrow.”

The loan scheme is structured so that no lending country incurs a loss on its loans to Greece. If a country borrows at a rate greater than the rate Athens pays to lend to Greece, other countries who make profits on the loans will have to make up the difference.