The Prodigal Greek

The Greek crisis through a different prism

Chancellor, your heart and Greece don’t need to bleed anymore

with 2 comments

“This government has some legitimacy, and it has found some support in Europe. And now it is being pushed to make further cuts to the bone that may risk a social explosion”. This is a comment, reported in a recent New York times article, from an unnamed official involved in the discussions between the Greek government and the troika over the latest round of austerity measures, 11.5 billion euros or 6% of GDP worth of spending cuts, that need to be agreed so the troika gives Greece a favourable review that will unlock the release of the next tranche of financing.

Since Greece signed the first MoU in May 2010, Greece’s political establishment has been looking no further than three months at a time, in between troika reviews. Since the Spring of last year, when the first program’s recessionary policies began to damage the economy and the macroeconomic framework, there has been constant battle to bring the program “back on track”. This anxiety and uncertainty has transferred itself to the Greek society.

Greece’s creditors – eurozone countries, the European Commission, the IMF, and the European Central Bank – have suffered from a similar short-sightedness in their crisis management. If I have not lost count, it has taken 20 EU leaders’ summits so far without a decisive solution to the evolving sovereign debt crisis. This muddle has been going on for so long that perhaps everyone involved and observing believes this is the only method of crisis resolution available. This perception is wrong.

Greece has often been referred to as a “unique case” and compared unfavourably to Portugal, the good pupil. However, Portugal’s inability to comply with its program targets, leading to a one-year extension being granted by the troika, and the recent protests that forced the government to abandon a planned increase in employees’ social insurance contributions is evidence that the time has come to change the narrative. It is time to consider other options available to tackle the Greek crisis, options that mean lenders do not lose out and Athens can ease up on the measures choking its economy.

Greece’s coalition government has spent its first hundred days in office wrestling with figures to produce a package of spending cuts that will bring the budget in 2014 to a primary surplus of 9.2 billion euros. The aim of Greece’s creditors is a primary surplus to a level – 4.5% of GDP – that will allow the government to service its debt. However, following the debt exchange earlier in the year, Greece owes 194 billion out of the 303 billion euros of total debt to the official sector. Of this, eurozone member states account for 53 billion euros in bilateral loans from the first program, the IMF loans amount to 22 billion euros, 74 billion to the EFSF while the ECB – and other eurozone national banks – hold approximately 45 billion euros of Greek bonds that were excluded from the recent PSI.

The tactic of the coalition government has been to extend the fiscal adjustment period by two years, until 2016. The media, particularly from Germany, over the last few days has been reporting various figures on the financing gap – or in a confused manner the budget deficit – that this extension translates into. But there is another way to resolutely address the Greek issue. As long as there is the political decisiveness, the troika can achieve both fiscal and debt sustainability that will effectively bring the Greek drama to the closing act. The ECB has a pivotal role to play.

A very generous portion of Greece’s second program goes towards uninterrupted servicing of the debt held by the ECB and other national euro area banks. Greece pays annually in the region of 2.5 billion euros in interest, approximately 30 billion of these bonds mature during the life of Greece’s second program, by 2014. To bypass the rigidity of the ECB, or the Bundesbank, on the issue of “monetary financing of states”, ECB/NCBs will only have to roll over the maturities of the bonds they hold, without a haircut to the purchase price of those bonds. The rollover of ECB/NCBs maturities releases 30 billion euros of EFSF funds that can be used for debt reduction purposes through the purchase and retirement of Greek government bonds (GGBs) in the secondary market. The new GGBs after the PSI trade at just 25 cents to the euro, despite their rally after the June elections. Even assuming a price increase of 50% as a result of the purchases, 27 billion euros of the redirected EFSF funds are required to purchase the circa 72 billion of nominal debt held by the private sector, with a net debt reduction effect of 45 billion euros, or 22% of 2012 GDP.

Combined with this politically neutral action from the ECB/NCBs, Greece should bring on the table the direct recapitalisation of the Greek banks from the ESM. At the moment, the 48.8 billion euros of this recapitalisation are planned to sit on Greece’s debt pile as obligation to the EFSF with very long maturities. In spite of the recent unjustified objections regarding “legacy” issues by the AAA group of eurozone finance ministers following a meeting in Helsinki, Greece is eligible to benefit from this decision of the June 29 summit and “break the vicious cycle between banks and sovereigns”.

Just these two developments can relieve Greece of approximately 95 billion of debt, or 47% of GDP. They are not politically sensitive as the roll over does not use the balance sheet of the ECB to finance states, something that is anathema for the Bundesbank and the Germans, and the direct recapitalisation from the ESM is only a matter of equal treatment of “similar cases”. Out of all the scenarios and actions to achieve debt sustainability that we have seen over the last two years, none has this decisive effect of putting Greece’s debt trajectory back to a sustainable path.

Equally important to the debt sustainability, are the near-term budget needs, something directly linked to the new austerity measures that will only push Greece further into the austerity/recession spiral and potentially test the patience of the Greek citizens with unpredictable social and political implications.

Greece in 2012 will pay approximately 8 billion euros in interest to the European side of creditors. 1.6 billion euros – 3% annually – for the bilateral loans of the first program, 2.5 billion – an aggregate 5% – to ECB/NBCs on the bonds they hold and 4 billion euros to EFSF – an estimated 4%. Even when confronted with the rigidity of the ECB that would resist reducing the coupon payments in line with the private sector – with a potential annual reduction in interest payments of circa 1 billion euros – a margin reduction of the bilateral loans from 150 basis points to 50 will reduce interest payments to euro area states by 1 billion euros. Equally, since the second Greek program was designed, the EFSF has managed to issue paper with very low rates so the interest rates charged to Greece can be reviewed even down to half, with an annual interest payment reduction of 2 billion euros. Combined with circa 1.4 billion euros of interest payment savings from the retired debt of the purchases, a total of 4 billion euros – over 5 billion if the ECB acts as a central bank tackling a crisis and not a profit seeking organisation – in interest payments is lifted off the Greek budget.

Such simple and non costly concessions reduce by an equal amount the volume of austerity measures that the Greek coalition government is asked to implement, measures that risk tipping Greek society over the cliff. Although repeatedly reported it is continuously ignored that the Greek people through a relentless reduction of disposable income via tax increases and income reductions have managed to erase over 20 billion euros of the state’s primary deficit – that is 10% of GDP – while a primary surplus is expected next year. 7 billion euros of cuts from pensions, public sector wages and social welfare will only give the final blow to an economy that by the end of this year will have lost 20% since 2009 but most critically will test Greece’s social cohesion and cross the tolerance level of a society already exhausted from two years of draconian austerity that have left one in four Greeks without a job.

Reducing the magnitude of the consolidation effort will create the social and macroeconomic environment that will divert the focus on Greece’s structural problems in the public administration and the economic model. The argument that often airs in northern Europe that making allowances for Greece will only give the Greek political establishment an opportunity to relax reform efforts is unfounded. The troika has shown so far that it has the necessary leverage to apply the pressure on successive Greek governments that eventually delivers what the creditors expect. Greece’s political elite will still need favourable quarterly reviews to keep open the funding line of the program so the troika maintains the upper hand only this time on commitments to fixing the structural issues and implementing the required reforms.

When there are a number of available options to address the Greek crisis, options that do not carry political costs or additional financing, it is irrational to carry on the course that has driven parts of the country’s population below the poverty line, risks wiping out large parts of the middle class and led to the radicalisation of Greek society, which sees an ultranationalist party third in recent polls with its members roaming the streets attacking immigrants.

Mario Draghi, following a recent meeting with the German Chancellor, said that “the euro supports openness, growth and prosperity. And ultimately, it supports peace and stability”. Now is the time to back words with actions because these supposed principles of the euro are fading away in southern Europe.



Written by Yiannis Mouzakis

September 28, 2012 at 2:06 pm

2 Responses

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  1. […] have lent Greece around €53bn in bilateral loans and the EFSF has lent around €74bn (h/t Yiannis Mouzakis for some of this number crunching). At the end of 2012, the IMF has estimated that Greece’s general government debt burden will be […]

  2. […] suggestions are the latest in a series of ideas put forward by economists and commentators that would allow Greek debt to be tackled decisively, Greece to be able see on the horizon an exit […]

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