Painful choices still hang over Greece
The IMF now acknowledges that the programme agreed in 2010 was wildly unrealistic
Tourists watch the march of the Presidential Guard (Evzoni) in front of the parliament building in Athens. The most disturbing aspect of the Greek macroeconomic situation is its external position, not the fiscal one
Is there a path towards making Greece a successful self-financing economy within the euro zone? What would be required to put it on that path?
These are the big questions about the economic plight of Greece and its ghastly relations with its partners. Neither has much to do with what is going on, which is “extend and pretend”: the eurozone pretends Greece is not in default; Greece pretends it will reform; and both play for time. What would an honest reckoning look like?
A starting point must be with the latest debt sustainability analysis from the International Monetary Fund. One can sum this up simply: we would like to apologise for the mess we have made.
The fund admits that the programme agreed in 2010 was wildly unrealistic. Moreover, even the debt relief imposed in 2011-12 was insufficient, unless one believed in the plausibility of the “very ambitious targets for growth, the fiscal surplus, and privatisation” proposed by the Greek government, with support of its eurozone partners.
Subsequent events, however, demonstrate that these targets were indeed unachievable. Finally: “In all key policy areas — fiscal, financial sector stability, labour, product and service markets — the authorities’ current policy plans fall short of what would be required to achieve their ambitious fiscal and growth targets.”
This, then, is an effort at realism. It argues, rightly, that Greece will not achieve a sustained primary fiscal surplus (before interest) of 3.5 per cent of gross domestic product. The additional fiscal adjustment of 4.5 per cent of GDP needed for this will not happen. This would be difficult anywhere. In a country possessing a dysfunctional tax system and administration, in the midst of a huge slump, it is out of the question. Instead, the IMF assumes a primary surplus of 1.5 per cent of GDP.
Furthermore, the IMF has lowered its long-term growth trend to 1.25 per cent a year. It also assumes that interest rates on triple-A rated eurozone debt will ultimately rise from today’s levels, leading to an increase in the rates now charged on Greece’s official eurozone debt (a weighted average of 1.2 per cent). Finally, it assumes that Greece will have to pay an initial rate of 6 per cent when it returns to the market. In conclusion, debt is unsustainable, in terms of both the stock and “gross financing needs” — the funds needed to service debt.
In order to make debt sustainable, without a reduction in its face value — which eurozone members want to avoid — there need to be further substantial extensions of maturity and deferrals of payments, as well as the fixing of official interest rates at not more than 1.5 per cent. In effect, eurozone members would have to compensate the European Stability Mechanism, the EU’s bailout fund, for losses caused by fixing the interest rate on Greek loans. This would visibly be a “transfer union”.
This reckoning is brutally pessimistic, instead of fancifully optimistic. But is it too pessimistic and does it require action now? The argument that it is too pessimistic is that, with modest improvements and renewed support from the European Central Bank, the Greek economy and so debt position might end up far better than envisaged. If so, the terms on which Athens could borrow from the private sector might be far better. The argument that the euro zone can wait is that, so favourable are debt service payments on official debt, action is not now needed. The best policy is to wait, as Wolfgang Schäuble, German finance minister, wishes.
So what, in the light of all these uncertainties, is to be done? There are three realistic options for the euro zone.
The first is to continue, as now, probably for decades, doling out just enough money to keep the Greek show on the road, while insisting on targets that could deliver sustainability, but will not be met. Meanwhile, the Greek government will go on complaining, like a permanent adolescent, over the stinginess of those acting as its guardians.
A second option would be to break out of this pattern of behaviour by admitting that envisaged primary surpluses are unrealistic. In addition, permanent reductions in the present value of debt must be traded against measured reforms and only after their achievement. The reforms would cover the state of administration, the tax system and the functioning of the market. Even fairly modest reforms might transform today’s situation for the better. At the same time, we must recognise that Greece is as much a development challenge as one of macroeconomic adjustment. Institutions do change slowly.
A third option, rejected so far by the Greek people and the euro zone, is to accept that it just cannot thrive within the euro zone. The most disturbing aspect of the Greek macroeconomic situation is its external position, not the fiscal one, on which the IMF focuses. Yet, despite its huge depression, Greek trade is still not in surplus. Worse, export volumes are more or less flat; all the adjustment has come via compression of imports. If domestic demand were to recover, the external deficit would surely start to rise substantially, once again. Who would finance that? If nobody would do so, the financing of the external deficit would prove the binding constraint. Greece would then be stuck in a permanent slump. There exist only two plausible ways out of that: permanent transfers or a huge real depreciation. The latter simply cannot occur quickly enough inside the eurozone. The option of Grexit would re-emerge, however hard it may be to make it work.
Meanwhile, the IMF has to decide on its own position. It has now thrown down the gauntlet to the eurozone. Germany wants the IMF in, but not the IMF’s demands on debt. So Berlin must choose. If the IMF does not get the concessions it seeks, it is honour bound to withdraw from the Greek mess. It should do so. It might be unable to save Greece. But it can at least save itself.
- (Copyright The Financial Times Limited 2016)