Debt adjustment has to be meaningful
The IMF is right in demanding definite, far-reaching relief measures to address Greece’s debt sustainability problem but the European lenders, driven by political considerations, are opting for a lighter, conditional, piecemeal approach based on an unrealistically high primary surplus in 2018 and beyond, doing what they know best: kicking the can down the road. This is not good neither for Greece nor the eurozone.
Talks between the IMF and the EU on ensuring the sustainability of the Greek debt are under way but the two sides do not appear close to clinching a deal, according to various reports. Nevertheless, a number of pundits think there will be some kind of compromise at the end because nobody wants the Greek crisis to re-emerge, mainly because of political and geopolitical considerations. Pundits admit that IMF staff want to stick to their positions but the Fund board is dominated by the US and EU countries. Therefore, they conclude, the international organization is more likely to compromise at the end of talks with the eurozone, even if it takes weeks or months.
To back their view about the influence exerted by non-economic events on decision-making, they argue that the outcome of the last Eurogroup would have been different if it were not for the resignation of former Turkish premier Ahmet Davutoglu, which fanned concerns about the fate of the EU-Turkey deal on refugees. The resignation played an important role in changing the attitude of some key players in the last two days leading to the Eurogroup, according to the pundits.
It is reminded that the refugee crisis is much more important for the traditional political parties in Germany and other eurozone countries than for the Greek crisis. The large number of refugees and migrants who made it to Germany and other countries in 2015 are blamed for helping fuel popular discontent and providing support to extreme political forces. The strong showing of the AfD party in opinion polls in Germany and the strong performance of the extreme right in Austria speak volumes.
Therefore, it comes as no surprise that Germany and a few other countries are eager for the Greek economic crisis not to re-emerge at this juncture. However, their insistence on placing a lot of importance on fiscal austerity to restore market confidence in the country’s ability to repay its debts and much less on providing meaningful debt relief does not lead to a viable, long-term solution in our view.
We have long argued that primary budget surpluses, where receipts exceed expenditures excluding interest payments, to the tune of 3.5 percent of GDP from 2018 onwards are not realistic and we do not think markets will swallow it that easily. The IMF proposes that the surplus target be set at 1.5 percent of GDP in the medium-term. The Greek central bank thinks a 2 percent of GDP surplus in 2018 and beyond is appropriate. We note that Greece has not attained a 3 percent of GDP surplus or higher in decades, at least since the late 1970s, and the odds are against it meeting it in the medium-term given its economic situation.
In addition to the high fiscal hurdle, Greece cannot hope for meaningful debt relief from 2023 and beyond, according to a document prepared by the European Stability Mechanism (ESM) and reported by Reuters as well as German newspaper Die Welt. In the baseline scenario, which forecasts Greece maintaining a primary surplus 3.5 percent of GDP during 2018-2025 and growing at 3.1 percent in 2018, 2.8 percent in 2019 and 2.5 percent in 2020 among others, the eurozone could take some steps to lighten the debt burden.
In the period to 2018, it could buy part of the IMF loans outstanding from unused funds under the ESM program and return profits generated by the ECB on its Greek bond holdings to Athens. It is noted that the return of ECB profits was included in the second bailout program. Assuming Greece complies with the third program requirements, if needed in 2018 the ESM could decide to extend maturities on official loans by 5 years, set loan repayments at 1 percent of GDP until 2050 and cap annual interest payments at 2 percent until 2050.
The terms could change if the adverse scenario materialized. However, the German side poured cold water on the proposal for capping the interest rate at 2 percent of GDP, so we can assume it will not be on the table.
Debt talks continue so it is prudent to wait and see where the buck will stop. However, at this point, the dribble of debt relief proposed does not constitute a viable, long-term solution to the sustainability of Greek debt. This means the issue will be revisited in due time by the eurozone and the Greek government if the above proposals stick and the IMF backs down. Structural reforms are definitely important but they are unlikely to deliver with the strength envisaged in the GDP projections. Therefore, they should not be seen as a substitute for debt relief.
Undoubtedly, the drag from fiscal austerity could be partly offset by a faster growing eurozone and world economies, steady or lower international oil prices and low euro interest rates, as well as the return of business confidence and the improvement of sentiment in Greece via a large inflow of EU structural funds. Even so, the debt-deflation spiral could prove more difficult to break and Greece will find it more difficult to tap world markets if debt relief is not meaningful. Unfortunately, lessons not learned must be relived.
[Kathimerini English Edition]
