The new European Union
This article originally appeared on Vox on 14 Jul 2015
The new bailout deal for Greece was not easy. This column argues that it was also a failure. It will not be enough to recapitalise banks, it asks for structural reform that exceeds Greek capacities, and it raises the Greek debt-to-GDP ratio to unsustainable levels. In a few months or quarters, the programme will fail and the Grexit question will flare up again.
The Summit of 12 July faced the risk of making two mistakes: inadvertently pushing Greece out of the Eurozone, and agreeing on a mistaken strategy. It achieved the amazing feat of making both mistakes and radically altering the monetary union.
The reason why the Heads of States and Governments were meeting once again was that the previous programmes had failed. Of course, Greece did not deliver on its commitments, for several reasons, one of which is that it never had a chance of delivering.
The failed Greek bailout programmes
Back in 2010, the Greek debt was already excessive. The economic logic, secretly proposed by the IMF, was to cut the debt deeply enough to avoid a crippling, front-loaded fiscal contraction. Instead, Greece plunged into a deep depression.
- The sum of the GDP shortfall, the difference between each year’s real GDP level and the 2007 level, amounts to 135%.
It remains to be seen whether any country in modern history has suffered such a loss in peacetime.
- In the face of rapidly dwindling tax receipts, the Greek government has managed to reduce its deficit from 15.3% of GDP in 2010 to 3.5% in 2014, and to a small surplus net of debt service, probably another record.
Despite this huge fiscal cutting, the depression meant that the debt-to-GDP ratio continued to rise.
The very same failed logic was upheld when a second programme was adopted in 2012, replacing the uncompleted first one, which was officially declared a failure. On the morning of 13 July 2015, the Summit formally agreed on a continuation of the same strategy: no debt relief, more fiscal contraction.
- The Greek depression will deepen again and produce the same results as before, unless a supply-side miracle occurs due to the previously enacted structural reforms (which are much deeper and wider than recognised by most – see Whelan 2015).
The new programme will add another 25% of GDP to the existing debt.
- In a few months or quarters, the programme will fail and the Grexit question will flare up again – that is, if political turmoil has not led Greece to leave beforehand.
By then, the Greek economy will be even weaker and even less able to absorb the poison that it was been served relentlessly since 2010.
- Grexit is becoming a self-fulfilling prophecy whereby the Greek travails prompt ever worse policy conditions imposed by the rest of Europe to avoid Grexit.
The burden of debt and credit market access
De Grauwe (2015) asserts that the net present value of the Greek debt is about half its nominal value. The reasoning is based on the extension of the debt maturity, on the ten-year interest service grace period on its ESM debt and on concessional interest rates. Of course, the calculations are highly sensitive to the discount rate assumption, which merits being flagged even if the qualitative conclusion remains valid. Yet, that cannot be the whole story.
The main, if not the only, objective of assistance programmes of this kind is to help a country recover market access. Indeed, it is the loss of market access that leads countries to seek official financial assistance. How do markets assess the ability of a country to borrow?
Ideally, markets would look at the net present value, as de Grauwe suggests. In practice, they (also) look at the face value for the debt-to-GDP ratio for more or less valid reasons (accounting rules, risk assessment, etc.). There is simply no scope for Greece to recover market access with a nominal debt burden that is close to 180% of GDP now and bound to rise to above 200% with the new agreement. The explicit rejection of haircuts in the agreement is taking a step away from Greece gaining market access. An implication of this reasoning is that the highly conditional signal that the debt’s maturity might be lengthened, with a further grace period, is unlikely to help.
Privatisation and bank recapitalisation
Another disturbing aspect of the agreement is the requirement that Greece privatise €50 billion of state assets. Beyond the amazing intrusiveness of this condition – aggravated by the mandatory transfer of the assets to a newly created fund – one can only wonder how this amount was set. It would be reassuring to know that someone competently assessed the value of state-owned assets, taking into account the depressed state of the economy.
An additional concern is that half of the income from sales should be earmarked to bank recapitalisation.
- Since it takes months and possibly years to sell state-owned assets, the implication is that banks will not be recapitalised any time soon.
The agreement includes the promise of early disbursement by the ESM of €10 billion for bank recapitalisation. However, this amount seems to fall far short of what is needed to reopen the banks. After all, Greeks banks have experienced:
- Withdrawals totalling €33 billion between September 2014 and end May 2015 (financed by collateral subject to a deep discount);
- High levels of non-performing loans; and
- A loss in value of the government bonds they hold.
Structural reform disappointments
Finally, the structural reforms requested in the agreement are highly desirable. If enacted, they would represent a unique overhaul of a deeply inefficient economy. Yet, this seems to be wishful thinking.
The long list of reforms raises deep issues of intrusiveness and political acceptance – a fine line that the IMF has long learned to tread carefully with heavily indebted nations. The known limitations of the Greek administration, along with those of the Code of Civil Procedure (also earmarked for reform), strongly suggest that the laws that the parliament could adopt under pressure (and in record time) will not be implemented.
When programme reviews come in the future, they will find that implementation has not been satisfactory; fund disbursement may be suspended. Grexit will follow.
In conclusion, the conditions asked of Greece are not likely to be met, because they cannot be met. Greece will be blamed for not living up to its commitments, as it has been this time around.
Yet, somehow, the notion of asking for the impossible from a country that has no choice but to sign is fundamentally perverse. The view that a country should be forced to take steps that it does not want to take is a violation of the principle that the EU is a union of countries that are equal. These reforms are not needed for Greece to be a member of the Eurozone. A country can be an impoverished member as long as it does not cost anything to the others.
- The mistake was to break the no-bailout clause that was designed to make sure the Eurozone would not find itself in this position.
For selfish reasons (i.e. preventing a bank crisis in Europe and the US), Greece was convinced to accept the first bailout in 2010. This is what may justify the extraordinary intrusiveness of this week’s agreement.
The right policy is to not lend, to not ask for reforms and for the ECB to deliver on its mandate of safeguarding financial stability, at Greece’s expense. Of course, this all assumes that the debt is reduced. Once it is not, we climb the ladder of second best, third best, fourth best, etc. Once up there, we are all sure to fall.
De Grauwe, P. (2015) “Greece is solvent but illiquid: Policy implications”, VoxEU, 3 July.
Whelan, K. (2015) “The FT Lets Itself Down Again: Francesco Giavazzi on Greece”.