Greece’s Economy Is in the Recovery Room

3 November 2015
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By Leonid Bershidsky
Bloomberg

Greece has been gone from the headlines since Prime Minister Alexis Tsipras was re-elected to run the country in September. No news is good news, and Greece has been doing better than expected despite its customary slowness in responding to creditor demands. That is no reason for complacency.

Greece’s Financial Odyssey

While not out of the woods, Greece’s large banks seem to be showing signs of life. The European Union rescue plan allocated up to 25 billion euros to recapitalize the banks. A European Central Bank assessment released last week found a capital shortfall from 4.4 billion euros ($4.9 billion) up to 14.4 billion euros (under a scenario where growth is substantially lower) in the country’s four largest banks.  The banks have to submit capital plans on how they will cover the shortfalls to the ECB by Nov. 6, which will start the recapitalization process.

Another good sign is that Greece’s purchasing managers’ index, a leading indicator of economic growth, has rebounded to the highest level since May after falling to an abysmal 30 points in July, when capital controls brought the country to a standstill:

GreekPMI

Though the current PMI, 47.3, is still below 50, indicating a decline, the Greek economy is likely to shrink less than international creditors expected. Last week, Deputy Finance Minister George Chouliarakis told the Greek parliament his ministry expected the Greek gross domestic product to slip 1.4 percent this year, instead of the 2.3 percent drop indicated in the bailout plan and the ECB’s baseline scenario. That means if Chouliarakis’s forecast is correct, the banks will need even less capital than the ECB says. Bloomberg’s consensus forecast is for Greece’s  economy to shrink just 1.1 percent this year.

In short, creditor predictions were probably overly pessimistic. The situation is still ugly, but it’s not horrible. All the Greek government has to do to keep its head above water is to implement the so-called “prior actions” — legislation reforming Greece’s tax, pension and other vital systems that are preconditions of the bailout. It is working on that, though it missed the soft Oct. 29 deadline for the “prior actions,” and so didn’t unlock the latest 2 billion euro aid tranche.

Greece’s creditors will probably release the money soon, though. The government scrambled to push through most of the required legislation.  While by mid-October, only 30 percent of it was in place, by the end of the month the government got to 90 percent. The remaining difficulties are non-essential: The government and the creditors are arguing about things like value-added tax on private schools and the licensing of pharmacies. This shows how deeply outside experts are involved in running Greece these days. The government has practically no leeway, but it has learned to take the prescriptions without calling for mass rallies or nonsensical referendums of the kind Greece saw earlier this year. Tsipras has also proved efficient at pushing the required austerity measures through the parliament, virtually unrecognizable as the radical firebrand who nearly derailed Europe’s common currency project just last summer.

The motivation for good behavior is that European leaders have promised to open debt relief talks if Greece does as told. In a recentpaper, University of Michigan’s Christopher House and Linda Tesar show that reaching fiscal targets at the speed written into the bailout plan carries a cost, unless the debt repayments can be reduced from the current 4 percent of GDP annually. If that can be achieved, however, there will be growth benefits to delaying further austerity.

Tsipras is hoping that, by proving cooperative, he will reduce debt repayments. Under current terms, Greece has to repay a forbidding 319.5 billion euros by 2057. The International Monetary Fund bolsters that hope by putting forward debt restructuring as a condition of its participation in the Greek bailout.

European finance ministers will be sorely tempted to put off debt relief negotiations, since Greece appears to be doing better than expected. Avoiding a deal, which would probably include maturity extensions and interest reductions, is risky: At any moment, the Greek government could get tired of playing teacher’s pet if no reward is forthcoming. Agreeing to debt relief too soon, on the other hand, could also demotivate Tsipras.

A fine balance must be struck. As in other  situations where creditors dictate reforms — Ukraine is another example — the focus in Greece is too much on fiscal measures. It is easy both for the government and the creditors to forget that, with macroeconomic policy severely constrained, the only way to boost the economy is through structural reforms and deregulation, which is the only area where the government has some leeway. For example, the government needs to figure out how to make export-oriented industries more competitive and to remove regulatory barriers which make Greece one of Europe’s toughest countries in which to do business. As Harvard University’s Dani Rodrick pointed out in a recent column, “the more orthodox Greece’s macro and fiscal strategy is, the more heterodox its growth strategy will have to be.”

Tsipras has proved he can learn from his mistakes. Now, however, he needs to go beyond these lessons and start inventing ways to make life easier for Greek businesses and investors even as he keeps the creditors engaged. Without creativity, obedience will lead to a mediocre outcome.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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