Greece urgently needs more debt relief—will it get it?
In August Greece is due to leave its third bailout programme. That exit will be one to celebrate unlike the potentially catastrophic Grexit from the euro so narrowly averted in the summer of 2015. The hope is that it will close a tumultuous chapter in modern Greek history, which started with the first rescue in May eight years ago, included the write-down of over half of its privately held sovereign debt in 2012, the first default by an advanced country for more than half a century, and featured the no-holds-barred confrontation with Germany and other official lenders in 2015. But is Greece in any fit state to return to the markets while its debt still remains so high?
After a devastating collapse in economic activity over the past decade there are some signs of revival. The economy is now recovering from the further blow inflicted by the brinkmanship of Prime Minister Alexis Tsipras and his radical-left Syriza ruling party in the first half of 2015. In a belated reward for avoiding Grexit, Greece grew by 1.4 per cent in 2017, the fastest since 2007. The European Commission expects growth of 1.9 per cent this year, outpacing the 1.4 per cent forecast for Britain by the Bank of England as the economy pays the penalty for Brexit. The Greek budget—whose ballooning deficit of 15 per cent of GDP in 2009 so alarmed investors that the first bailout became necessary—is now in the black and there is a big surplus on the primary balance, which excludes interest payments.
Casting an ominous shadow over these encouraging developments is Greece’s skyscraper government debt, whose face value amounts to almost 180 per cent of GDP. That is double the level of around 90 per cent in Britain and the euro area. It is particularly worrying because Greece has a habit of reneging on its sovereign debt, having been in default for half the time since it gained independence in 1830.
While Greece remains in its bailout programme, in which it receives financial assistance subject to strict economic and fiscal conditions, the scale of its debt does not matter because it does not influence the interest that the eurozone rescue fund is charging on its loans. And because three quarters of the total debt is now in official hands and subject overall to very low rates, the burden is manageable.
But once Greece leaves the three-year programme and finances itself in the markets, its high debt will matter because private investors will take it into account in the rates at which they are prepared to lend to Greece. The worry is that as the existing cheap official loans mature and are repaid they will have to be refinanced through new bonds at much higher rates. That will raise Greece’s overall financing costs, which include the repayment of principal as well as interest payments. Once again Greek public finances could spiral out of control, as occurred before the first bailout in May 2010 when investors lost faith and yields on sovereign bonds rose to intolerable levels.
In assessing this threat to Greek debt sustainability, it is not just interest rates that matter. Greece’s growth rate is also critical since this determines the future size of GDP, the tax base. The collapse of the economy during the crisis, shrinking by over a fifth between 2009 and 2013, is one reason why debt remains so stubbornly high in relation to GDP despite the big write-down of 2012. The budgetary stance—whether Greece continues to run primary surpluses and if so on what scale—is also crucial. All these factors enter into calculations of sustainability over the decades to come.
A report by top economists recently published by the Centre for Economic Policy Research (CEPR) finds that on realistic assumptions about growth and future primary surpluses, Greek debt is indeed too high to be sustainable in the longer term. If Greece exits the programme in August without new debt relief, financing needs will eventually break through the threshold of 20 per cent of GDP that the IMF deems consistent with sustainability. This holds even in a projection based on the politically unfeasible case that any country, let alone Greece with its track record of defaults, can maintain primary surpluses of 2 per cent of GDP stretching decades into the future.
The authors’ assumptions are not holy writ. For example they are gloomy about Greece’s long-term growth prospects, arguing that 1 per cent over the long-term is reasonable and 1.25 per cent would be optimistic. Though this might seem low for an economy that has plenty of potential for catch-up growth, it takes on board a strong drag on growth from Greece’s ageing population. On the other hand, some of that demographic effect could be offset through a return of the Greek diaspora if things start to improve in Greece.
Despite such uncertainties the report’s main conclusion is economically convincing: Greece needs a reduction in the face value of its debt if its public finances are to be viable. But that is not going to happen. On any straightforward interpretation of the European treaty, the Greek rescue violated its ban on bailouts. Legal wriggle-room was then conveniently found by distinguishing the provision of loans from the assumption of debts. European governments have since consistently resisted any cut in the nominal value of officially held Greek debt. The CEPR report includes an ingenious legal argument to get round the ban but it will not fly in Germany, the key creditor country.
But debt relief does not necessarily entail direct cuts in the face value of outstanding loans. It can also come through stealthier means such as charging ultralow interest rates, deferring interest payments and stretching the period over which loans are repaid. Greece’s European creditors have already used these “extend and pretend” techniques to diminish the effective burden of Greek debt, but there is still scope to do more. For example the repayments on the loans from eurozone countries in the first bailout, which are due to start in 2020, could be delayed and extended over a longer period. The repayment schedule of loans made in the second bailout through the currency bloc’s temporary rescue fund (the European Financial Stability Facility set up post-haste after the first Greek rescue) could also be shunted out further into the future.
Eurozone finance ministers will decide in June how they will treat Greece when it leaves the programme two months later. An advantage of their preferred indirect method of debt relief is that it will provide creditor countries led by Germany with continuing leverage. They will no longer be able to link disbursements of funds to strict compliance with economic and fiscal conditions as at present. But they can maintain influence by phasing relief and tying it to continuing budget discipline while providing flexibility through a link to how well or badly the economy is performing. This may not be the ideal approach but it is the most plausible way that Greece will get the further relief it still desperately needs.
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