Greece rewrites economic textbooks with austerity on austerity

It could be a chapter in an economics textbook: What happens when severe austerity is imposed on an economy that’s already lost a quarter of its output?

Greece will find out how bad it could be.

The package of measures that Tsipras was strong-armed into agreeing to early Monday after an all-night summit with euro leaders requires pension curbs and tax increases, with no promise of debt relief. To prove his commitment to reforms, Prime Minister Alexis Tsipras must pass those measures through parliament as early as Wednesday.

The country’s economic slump has already saddled it with a 26 percent unemployment rate as previous governments implemented budget cuts at the behest of creditors, and output may fall by 10 percent this year. The International Monetary Fund admitted in a report two years ago that it underestimated the recessionary impact of the original 2010 bailout plan.

“If there’s a permanently horrible business environment it just prolongs the agony,” said Gabriel Sterne, head of macro research at Oxford Economics in London. “It already is one of the worst post-crisis output performances ever apart from uber- commodity slumps and wars.”

Greece could also see a rerun of the kind of civil strife seen in central Athens up to 2012 during parliamentary votes on budget bills. While protests in recent weeks, both for and against a deal with creditors, have been peaceful, minor scuffles have broken out with riot police at rallies organized by anarchist groups. Public sector workers are set to strike on Wednesday, indicating the first general strike since November might follow.

Reform implementation

The prime minister has one hope, says Constantine Michalos, president of the Athens Chamber of Commerce and Industry: Succeed where previous governments failed and fully implement the market-opening reforms that were also part of the package Tsipras agreed to keep his country in the euro.

The seven-page statement issued at the end of the summit, which lists measures Greece must take before funds can be released for its cash-starved economy, begins with the need for “ownership” of the program by Greek authorities.

Ramping up state asset sales and liberalizing product markets are measures that Tsipras should embrace to foster growth in Greece, Michalos said in a Bloomberg TV interview. Without them, gross domestic product could be another 10 percent lower five years from now, he said.

“We needed a deal, come what may, because the only other alternative would have been absolutely catastrophic,” Michalos said. “Greece can’t stand on its own two feet with national currency, the old Greek drachma, simply because it’s not a production-based economy.”

Capital controls

The new fiscal measures will amount to at least 8 billion euros of tightening for this year and 2016. Meanwhile, the bank holiday and capital controls since June 28 risk plunging the country’s mostly state-owned lenders into insolvency. The summit agreement foresees the cost of re-capitalizing them as as much as 25 billion euros, or 14 percent of 2014 gross domestic product.

GDP contracted for a second quarter at the start of this year, putting Greece officially back in recession. The drop in GDP for the first half of the year is running at annualized rate of 10 percent, JPMorgan Chase Bank economists Greg Fuzesi and Marco Protopapa said in a client note on Monday, noting this estimate is a holder and could change.

Internal revolt

Tsipras is already facing a revolt within his coalition government, with the Left Faction of his Syriza party and his junior party in his coalition both indicating they will vote against the deal. Even if he passes the reform measures with support from opposition parties, as is likely, the revolt within his party risks early elections that would amplify the suffering the economic pain.

Among the measures that Greece will have to legislate by July 22 is an overhaul of civil procedures, which could speed up protracted court cases that have acted as deterrents to foreign investment. The IMF says state asset sales, ramped up in Monday’s plan, are necessary to improve efficient management of the resources as much as they are for raising revenue.

“The most important thing for debt sustainability is always a growing economy, which Greece has been lacking,” Moritz Kraemer, managing director of sovereign ratings at Standard & Poor’s, said in a Bloomberg TV interview. “It’s partly been lacking because there’s been so little progress on the reforms. They’ve been very successful on the recessionary austerity.”

Confidence boost

Tsipras told reporters in Brussels after the summit on Monday that while the package contains recessionary measures, he hoped this would be offset by the restoration of confidence after the threat of euro exit ends and financial stability is resorted. That uncertainty undermined the government’s efforts to negotiate a better deal as Greeks took 34 billion euros of deposits out of the country’s banks, 21 percent of the total, in the six months through May.

“The short-term economic impact will be to deepen the recession,” said Frederik Ducrozet, an economist at Credit Agricole SA in Paris. “ It’s a lot about confidence in Greece, or lack thereof so far. But ultimately it’s not completely unrealistic to expect a sharp rebound in the Greek economy next year if everything goes according to plan.”

[Bloomberg]