Why is the euro zone still arguing about Greece?
Greece cannot pay its own bills and debts, and is locked out of capital markets. It therefore needs financial support from “official” lenders: the euro zone and the IMF. But before coughing up bail-out funds, these creditors demand reforms and budget cuts to place the Greek economy on a sounder long-term footing. Some of these conditions have proved very difficult for successive Greek governments to meet.
This has been the choreography ever since the first Greek bail-out five years ago. But in January, brutalised by an economic depression that saw output drop by one quarter of GDP, Greece’s voters elected a government led by the radical left-wing party Syriza. Armed with a mandate to tear up the hated “memorandum” (the creditor-imposed conditions for assistance), the government, led by Alexis Tsipras, set about trying to change the terms of Greece’s second bail-out, which has €7.2 billion remaining in the kitty. But Greece’s creditors, including the other euro-zone governments, held firm. In February the two sides agreed to extend the bail-out by four months, until June 30th. But very little progress has been made since then.
What does each side want?
Last week the two sides issued competing sets of reform proposals, both of which subsequently leaked. Strong disagreements remain in a number of areas. Perhaps the trickiest is pension reform. The creditors want Greece to make various cuts to its generous pension system, worth 1% of GDP by next year. But further pension cuts run directly counter to Syriza’s election promise of ending what it calls Greece’s “humanitarian crisis”. Differences also remain over VAT, which the creditors want simplified and raised. The two sides look closer to a deal on labour-market reform, but have yet to find common ground on collective-bargaining rules and the minimum wage.
Then there is the overarching issue of Greece’s debt, which after two bail-outs stands at 180% of GDP. The projections each side has produced for Greece’s primary budget surpluses (ie, before interest payments) do not seem that far apart: both foresee Greece running a surplus of 3.5% of GDP from 2018 onwards, which would mean a reasonable decline in Greece’s debt-to-GDP ratio over time if it can sustain economic growth. But the creditors, in particular the IMF, do not accept that the Greek reform proposals will lead to such a figure. Perhaps the most important issue for Greece is the promise of some form of debt restructuring. Greece’s creditors are not in principle opposed to ideas such as extending loan maturities, but want to postpone the discussion for now.
Wasn’t Greece supposed to have run out of money by now?
It has purportedly been on the brink several times, lending a “Groundhog Day” tone to coverage of the saga. When its bail-out was extended in February few thought it could survive until June without a deal. The country has received no external financing since August 2014. It has stayed afloat only by resorting to a series of increasingly desperate measures, from raiding the coffers of municipalities to delaying payments to suppliers. It made one repayment to the IMF by borrowing from a separate account at the fund, and has exploited a rarely-used provision in IMF rules to delay all of its June payments until the end of the month. A missed payment to any official creditor could trigger bank runs, a loss of liquidity support from the European Central Bank (ECB), capital controls on Greek banks and, ultimately, a Greek departure from the euro if it is obliged to print its own currency to pay salaries and pensions.
What happens next?
Over the past four months endless deadlines have come and gone. But June 30th is different, for two reasons. First, Greece’s bail-out expires, meaning the €7.2 billion will no longer be available. (Nor will over €10 billion supposedly earmarked for bank recapitalisations, but part of which might also be used to help the government.) That also rules Greek banks ineligible for liquidity support from the ECB. Second, the bundled IMF payments, worth around €1.6 billion, fall due; Greece almost certainly cannot raise those funds without help. Beyond that, in July and August, Greece must pay the ECB around €6.7 billion.
Yet even a deal with the creditors would leave several questions unanswered. The first is whether Mr Tsipras would be able to sell it to his increasingly restive backbenchers. Some have suggested a referendum, or fresh elections, would be needed. The second is whether there would be enough time to get the deal approved by various euro-zone parliaments, many of which will spend part of June in recess and are anyway thoroughly fed up with Greece. The third is the role of the ECB; Greece wants the bank to lift the limit it imposes on Greece’s short-term debt (the so-called “T-bill ceiling”), which could provide a further source of funds . But it is not clear if the bank would do that before the euro zone agrees to disburse the bail-out cash.
What about this talk of a third bail-out?
It may be hard to believe, but the quarrels of the last few months are about a relatively minor issue: how to conclude Greece’s second bail-out. Even if a deal is struck the funds will quickly be swallowed up, not least by those ECB redemptions. As private financing is still not an option, Greece will be looking at a third bail-out. Back-of-the-envelope calculations put the sum needed at between €30 billion and €50 billion. Trust between the two sides has evaporated since Syriza’s election, meaning the creditors are likely to demand more onerous terms than they might have done.
Two things could sugar the pill for the Greeks. The first is that a third bail-out could include some form of debt restructuring. The second is that the involvement of the IMF, which has been very strict in pushing for reforms, is not guaranteed. Tensions between the fund and, in particular, the European Commission, have grown in recent weeks: in the absence of strong reforms the fund has sought debt restructuring to make its sums add up. The commission prefers political fudges.
Would a Grexit be devastating?
The effects on Greece would be deep and immediate, as money flees banks and Greek firms’ euro-denominated debts skyrocket as a new drachma plummets in value. In the long run, though, some suggest that the competitiveness gains from a currency adjustment could help Greece back on its feet. As for the euro zone, compared to 2012, when Greece was last on the brink, it is in better shape to manage a Grexit. Its banks are well capitalised, a large bail-out fund is established and 80% of Greece’s debt is now in “official” hands. Yet a Greek departure would signal that euro membership is contingent. Although swift action from the ECB could protect other vulnerable countries, such as Portugal, from immediate market attacks, in the long run their borrowing costs would rise permanently. The OECD has warned that a Grexit would hurt the European economy. And then there are geopolitical concerns: Angela Merkel the German chancellor, is said to be among those who fear the consequences of a fracturing Europe when Russia is menacing its neighbours. Since taking office Mr Tsipras has flirted with Vladimir Putin, notably over joint energy projects.
Whose fault is all this?
There is plenty of blame to go around on all sides. Europe’s politicians probably should not have allowed Greece to enter the euro in 2001, two years after the currency was created. Greek governments should not have used the state as an instrument of patronage, should not have spent wildly in the years before 2008, and—like Ireland, Portugal and Cyprus—should have used the opportunity of a bail-out to execute deep-seated structural reforms. The euro zone has been guilty of imposing far too much austerity on a battered economy, of loading up Greece with unpayable debt and of a tin-eared approach to the increasing desperation of ordinary Greeks. Europe’s politicians should not have been surprised that voters looked for a radical alternative, and they should have found more imaginative ways of dealing with it when it arrived. But Syriza has been a shambles in office, antagonising potential allies and destroying the trust it needed to secure a better deal for itself. It is an unhappy story which reflects poorly on all involved.