Allow Greece its overdue virtuous cycle
A quick technical fix can provide a long-term solution
You might be forgiven for the oversight. The electoral upheavals of the UK and France are deeply significant for the future of Europe, but the resolution of the Greek economic crisis matters too. And this week, talks about Greece’s “rescue” loan programme come to a head.
There are similarities with past talks: foot-dragging has delayed the latest disbursement of loans with only weeks to go before Athens is due to repay a large bond. There is still no concrete delivery of the debt relief promise that has been dangled in front of Greek eyes for years.
But the echoes are more faint than deafening. Everybody expects the next round of refinancing to come through imminently; there will not be a repeat of the 2015 nail-biting negotiations that could realistically have concluded with Greece being thrown out of the euro. The repeated delays, however, and the fundamental indecision over debt, are doing nobody any good: not the Greek economy, and therefore not Greece’s creditors for whom the worth of their claims hinges on Athens’s ability to honour them.
The main disagreement (well outlined by Simon Nixon a month ago) is between the International Monetary Fund and Greece’s European creditors. In summary, the IMF is more pessimistic about Greece’s growth prospects and its ability to sustain a large budget surplus than are eurozone countries. The institution is, as a consequence, more insistent on a commitment to debt restructuring by Europe that is more generous and more specific than what has been offered so far. Wolfgang Schäuble, the German finance minister, has publicly criticised the IMF for a low long-term growth estimate of just 1 per cent per annum over the next 40 years. Even the European estimate of 1.25 per cent is very low — but it makes a big difference to the required debt relief.
A cool look at the facts reveals that there is little logical reason for this disagreement to have become as big an obstacle as it has. The cause is twofold. First, the structure of Greek debt has already been so stretched out that its sheer size is not very meaningful; what matters is how much its service burdens the Greek economy from year to year. As a result, it is possible to limit this burden sufficiently without writing down the nominal amount owed by Greece, the reddest of red lines drawn by eurozone governments. That is one of the conclusions borne out by the most comprehensive analysis of the Greek debt situation by Peterson Institute economists (featured in Free Lunch last time we examined sovereign debt restructuring).
Second, because of the restructuring that has already taken place, it is not the size of the debt itself that is holding back growth. The Greek economy is so depressed that there must be significant potential for a strong acceleration once the brakes are taken off. Those brakes consist of a continuing squeeze on budget to achieve surplus targets; uncertainty about the short-term debt service burden and the possibility of a new refinancing crisis; and generally, doubts caused by never-ending talks which make people hold off on investing while capital controls and an exclusion from central bank bond purchases persist.
It is quite easy to imagine a virtuous cycle in which all three were reversed, which would prove misplaced the long-term pessimism of Greece’s creditors. Note that Greece returned to growth in 2014, when no fiscal consolidation was programmed or carried out (it fell back into recession with the political uncertainty of the following year when, importantly, government belt-tightening also returned with a vengeance).
Today, with the end of austerity in sight, the Greek economy has started to grow again, if weakly and fitfully. Unemployment is falling. Imagine the improvement that could be expected if a loan programme agreement coaxed the European Central Bank into including Greek bonds in its asset purchase programme.
The imperative, therefore, is to complete the austerity programme as soon as possible to give the economy room to breathe while minimising any debt refinancing needs in the short- to medium-term horizon. A cyclical upturn, if given time to grow, could turn economic and political expectations around, letting a recovery take root, and make all the numbers more favourable. That, in turn, might even allow a sustained, large primary surplus. While the Peterson authors note the very low frequency of such sustained periods of government surpluses, we should note that it is only the increase in government saving that hurts short-term growth; a large but constant primary surplus is compatible with fast growth (in the jargon, it amounts to a zero “fiscal impulse”).
The deal to be struck, therefore, should programme in no more fiscal consolidation, noting that Greece racked up a 4.2 per cent of GDP primary surplus last year. It should also deploy all resources unused in the loan programme to refinance upfront all debt falling due in the next few years. Finally, it should stretch out the remaining debt profile even further, along the lines suggested by the Peterson Institute paper.
How to get to such an agreement given the current stand-off? By recognising how much turns on the different expectations for growth. This disagreement should be turned around to acknowledge the following point. If the Europeans accepted the IMF’s view of growth prospects, they would also have to accept its call for greater debt relief given the commitments they have already made. If the IMF accepted European estimates, it would have to scale back the required relief it demands. Conditional on future growth, the parties are in agreement.
But there is no need to agree on the future growth assumptions. Instead, the conditional agreement can be built into the debt restructuring. Greece’s debt to the various European rescue loan mechanisms should be amended to incorporate GDP-linked payments to cap the debt service should growth disappoint — but accelerating payments should it outperform.
The Greek debt problem is a Gordian knot: a technocratic solution exists that can bridge seemingly gaping political differences. Not before time, that solution should be adopted now; the knot should be cut. Otherwise, a quarrel over minor amounts will continue to cause disproportionate economic harm to Greece and financial and political risk to everybody.
