By Zsolt Darvas
The talks between the new Greek government and Eurozone partners turned out to be as hectic and as tough as expected. Greece wants to get debt relief and fiscal space to spend more, revise structural reforms, stop privatisations and declare a political victory in turning down the previous bail-outs, while Eurozone partners want to stick to the terms of the bail-out agreements and keep a hard line position to prevent populist movements gaining more strength in other Eurozone countries. Not an easy circle to square.
At the time of writing this article, talks between Greece and its partners had again broken down. While some form of agreement on filling the short-term funding gap will likely be reached, there is a more important issue than surviving the next few months: finding a lasting solution. All previous attempts to address Greece’s pressing problems since 2010 have been short-lived and the spectre of a Greek exit from the euro area has recurrently returned.
The Greek bail-out programmes so far have failed. In the first bail-out agreed in May 2010, an output fall of only 7 percent was promised, a figure which was doubled in the second bail-out agreed in March 2012. However the actual collapse of the economy was about 25 percent. The ultimate aim of the bail-outs, ensuring sustainable market borrowing at the end of the programme, has not been achieved – and not just because of the current deadlock between the new Greek government and its official lenders. If there had not been snap elections in January, Greece would not have been able to borrow from the market at affordable rates. Even if an agreement is reached by the new government and its lenders and thereby the current very high market yields fall, market borrowing rates for Greece will likely remain too high.
In my view, the responsibility for the bail-out failures is shared between Greece and its official lenders, so all stakeholders have to consider options for finding a reasonable deal ensuring public debt sustainability, growth and social fairness. Given that about 80 percent of Greek public debt is in the hands of official creditors and sustainable market borrowing is not on the horizon, there are three options to address the debt conundrum: (1) much larger primary budget surpluses than the currently planned 4.5 percent of GDP and speedier privatisation in order to be able to repay maturing debt, (2) default or haircut on near-term expected debt redemptions (of which the maturing ECB-held bonds and IMF loans stand out in the next few years), or (3) new non-market financing. The only reasonable option I see for such financing is the use of the euro-area’s permanent rescue fund, the European Stability Mechanism (ESM).
Given that one of the principal demands of the new Greek government is a much smaller primary surplus than the currently-planned 4.5 percent of GDP,, one does not need a crystal ball to rule out option 1 above. Option 2 is clearly a no-go for euro-area partners and may not be necessary either. Any level of debt is sustainable if it has a very low interest rate and a long maturity; Japan is a prime example in this regard. Like it or not, Eurozone partners have socialised most Greek public debt with very long-maturity and low-interest rate loans. If they do not wish to suffer from a haircut (both in nominal and net present value terms), then they can extend the maturities and grace periods of current loans further and provide new loans to fill the funding gaps, according to the third option above.
I do not see any reasonable alternative to a new long-term ESM programme for Greece. The big questions are the modalities and politics. A lowered primary budget surplus would necessitate a larger ESM loan. The negotiations for the conditionality (including structural reforms and privatisation) bode to be a nightmare. And even if an agreement is reached by the negotiators, unanimity of all euro-area partners is needed to turn the agreement into a new contract, which will also require the approval of some national parliaments, which could be tough to achieve.
In the absence of a reasonable long-term agreement between Greece and euro-area partners, the new Greek government could either default on some of its obligations, which would have damaging consequences and may lead to a Greek exit from the euro, or the government could fail. A new election could easily lead to political paralysis, which could again lead to a Greek default and possible wide-ranging consequences.
I expect that fear of Grexit will prompt an agreement between Greece and euro-area partners. But my concern is that the agreement will be only a short-term fix and the various constraints will prevent reaching a lasting solution, thereby just postponing the problems. That would be the next stage in the Greek tragedy, as debt sustainability problems would likely return in a few years. In the meantime the resulting uncertainty would hold back economic activity, to the detriment of both Greece and its official lenders. Strong leadership and wisdom is needed to find a lasting solution.
Zsolt Darvas is a Visiting Fellow at Bruegel since September 2008 who continued his work as a Research Fellow from January 2009, before being appointed Senior Fellow on September 2013. He is also Research Fellow at the Institute of Economics of the Hungarian Academy of Sciences and Associate Professor at the Corvinus University of Budapest.
The article was written for Government Gazette.