2018-08-28
The modern-day Greek Odyssey that lasted for over eight years and shook the foundations of Europe has come to an end. Earlier this summer, after the euro area had reached an agreement on the country’s future, the Greek prime minister took off his tie and threw it away, as if shaking off the yoke of creditors. This evoked cheers of satisfaction from the parliamentarians that Alexis Tsipras had addressed. However, the symbolic gesture only partly reflects the real situation on the ground: the crisis has left deep-running scars, while Greece’s discretion to conduct independent economic policy will remain curtailed for a long time.
Comment by Simonas Algirdas Spurga, Senior Economist at the Economic Policy Analysis Division of the Bank of Lithuania
This week, following the conclusion of the third European Stability Mechanism (ESM) financial assistance programme, Greece joined the ranks of Ireland, Spain, Cyprus and Portugal – the euro area economies that have gone through square-bashing by European creditors and regained control over their national finances.
Having lost access to private capital markets, Greece has received €288.7 billion of international support since 2010 (an amount exceeding the national output more than 1.5 times). The country received loans from the International Monetary Fund (IMF) as well as euro area governments and institutions conditional on austerity and structural reforms.
In 2012, Greece managed to ease its debt burden, as private investors took a huge haircut on their holdings of Greek bonds, accepting the loss of more than €100 billion in loans. There are no similar mechanisms for writing off debts to public creditors (unless the country opts for the extreme path of bankruptcy).
Instead of winding down part of Greece’s financial obligations, Europe applied the so-called debt relief measures on several occasions, for instance, by lowering interest rates or extending maturities. According to the current arrangement, it will take slightly over four decades – up to 2060 – for Greece to repay its loans.
Hence, Greece has been given time to return on the path of sustainable economic growth, without having to worry too much about its obligations to international creditors in the near future. However, this does not mean that the issue of Greece has been settled, and that the country, having completed the stability programme period, may now independently do away with austerity.
Money disbursed, yet conditions imposed by creditors remain
After the last disbursement under the ESM programme, Greece made a commitment to maintain discipline and not to backtrack on its reform agenda. As part of the agreement with European creditors, the country will have to maintain a substantial primary budget surplus (excluding debt servicing costs) averaging 2.2% of GDP in the long run until its final debt repayment is made. There is very little room left for increasing public expenditure.
Consequently, Greece committed to pension cuts as early as next year, and a further tax system reform should be launched in 2020. Moreover, Alexis Tsipras’ government promised to implement an ambitious privatisation programme, thereby contributing to public sector cuts.
However, following the end of the programme, Greece has remained under the magnifying glass – the country will be subject to the so-called ‘enhanced surveillance’. This summer the euro area finance ministers also stipulated that some debt relief measures are to be revoked in case of any deviation from the course of structural reforms or fiscal discipline.
Such safeguards are deemed necessary so as to ensure the continuity of current policies, which would then allow Greece to repay its debts in the future. However, there is a legitimate question as to whether such requirements will not drive the Hellenic Republic into a corner. For instance, the primary budget surplus targets are particularly ambitious, and the creditors themselves are divided on the issue: according to the IMF, such long-term fiscal discipline as is expected from Greece is almost unprecedented. Furthermore, the government may try to shelve some unpopular decisions as early as next year, in the run-up to the next parliamentary election in October 2019.
In the event that Greece fails to fulfil its obligations, the aforementioned creditors’ sanctions would apply. This could trigger a negative reaction from investors and may even shut the door for Greece to the international capital markets. Consequently, the country’s access to external financing remains vulnerable, with its freedom of action significantly restricted.
Getting back on feet will be difficult
Whether or not a further stability support programme is needed in the long run will also depend on Greece’s growth and whether it can be accelerated by the implementation of the reforms requested by international creditors. This is particularly important as only a sustainably growing economy can regain the full confidence of financial markets.
Greece has not yet dug itself out of the hole it found itself in after one of the deepest and longest economic recessions in modern history: with the economy having shrunk by a quarter, the country has become one of the poorest EU countries. Greece suffered a blow as severe as the Great Depression in the US during the 1920s-1930s, only the negative consequences of the downturn have been felt twice as long.
The prospects of economic breakthrough are clouded by the still sluggish recovery in lending to the real economy, burdened by the inflated portfolio of non-performing loans (almost half of total credit), as well as factors related to demographic trends and slow labour productivity growth. Due to emigration and population ageing, the working age population in Greece in the coming decades will contract three times faster than the euro area average.
Downside risks may also be reinforced by the international situation since private creditors tend to invest in the Greek debt only when the possibility of systemic shock seems faint. For instance, in May 2018, when the Five Star Movement and the League started talks over the formation of a governing coalition, both Italian and Greek borrowing costs rocketed.
These circumstances are among the key factors that contributed to the IMF’s July assessment which stated that in the long term the Greek debt is unsustainable; according to the IMF, the level of public debt will start rising steadily in 2038.
As if addressing the IMF’s concerns, euro area finance ministers have committed to come back to this issue in 2032 and assess whether additional debt relief measures are necessary. It is then that the strongest disagreements over the repayment of Greek debts are likely to resurface – it will fall to the future generations of policy makers to take the final decisions.
Will Europe learn its lesson?
Hence, the situation in Greece is unenviable, and the prospects of debt repayment look vague. Former Greek finance minister Yanis Varoufakis believes that the end of the programme is only the extension of the country’s bankruptcy to 2060. On the other hand, according to Klaus Regling, ESM Managing Director, the role of euro area governments and institutions in the context of the Greek crisis should be seen as a triumph of European solidarity: the conditions of loans granted to the country, compared to the rates on private capital markets, allowed saving billions of euros for the national budget.
Nevertheless, the Greek economy continues to show signs of slippage. The country applied large-scale austerity (the so-called internal devaluation) at the bottom of the economic cycle. It seems that the pro-cyclical fiscal policy reinforced the vicious circle of shrinking consumption, falling investment and worsening public finances.
Does it mean that Europe should revise its strategy for dealing with economic crises? There is no clear-cut answer to such question since the Baltic States can be found at the opposite end of the spectrum. Despite an equally painful episode of fiscal consolidation, Lithuania and Estonia have already outpaced Greece in terms of the purchasing power of the population, and Latvia has caught up with it. Such diverging economic trajectories should provide plenty of food for thought for the EU decision makers.
One thing is clear: the Greek example shows that it is best to prepare for future challenges before the tide has turned. That is why, for example, after the crisis the European Union established various supervision and policy coordination mechanisms (such as the European semester) that would help Member States to implement a prudent fiscal and economic policy, in particular during the economic upturn. Unless the necessary buffers are built and the economy reformed in due time, meeting future shocks will be difficult.