Mikio Kumada, global strategist at LGT Capital Partners, argues that there are reasons for optimism on Greece.
Greece and its creditors seem finally close to agreeing on what is in effect a new financing program. Broadly as expected, the key breakthrough was reached in the last minute. Athens has given in, but also wrestled significant concessions: austerity is relaxed, reforms take social concerns into account, and Europe might even commit to some debt relief. The deal reaffirms what we already know: the dogma of austerity continues to fade in Europe, which supports growth. A new accord on Greece seems imminent, although it may still have to overcome a variety of hurdles before it is finally sealed.
Of course, many politicians, market participants, and the media will continue to stage dramas and create a lot of noise, making it more difficult for everyone to see what is actually happening. Still, some things are now visible quite clearly.
For starters, while the prospective deal can and will be often portrayed as a Greek “capitulation,” the truth is more nuanced. The Eurogroup and the International Monetary Fund have made significant concessions. The original program called for primary budget surpluses worth more than 16% of gross domestic product through 2018, while the new plan aims for just 9.5%. Other elements of the program have also been softened – in line with what was agreed in February, when Greece was given a greater say in the affair.
In essence, on the creditor side, there had already been a quiet recognition that Greece had taken too much austerity, too quickly, despite a persistent narrative that Athens has been dragging its feet (Karl Whelan, University College Dublin, provides an account in this context here: link).
On the Greek side, the new, leftist government had from the outset committed itself to “permanent” primary surpluses, which is of course at odds with Keynesianism, as well as its own campaign slogans. When two sides accept the basic principles, an accord is usually only a matter of time – especially when there are many other factors that incentivize a compromise.
What is likely to happen in the coming months
That said, what happens next? Perhaps the key take away from all this is that Europe’s decision-making, while tedious and complicated, is still capable of accommodating a diverging national interests and cultures, even under difficult circumstances. Like it or not, that is ultimately why the European Union and its currency are here to stay (with or without the UK, but probably with). At any rate, the more imminent events should play along the following the lines:
The revised Greek bailout will be extended in some form and followed by a third and final program, which will be smaller in size and more realistic by design than the previous ones. In this context, it is interesting to note that Finland’s Finance Minister Alexander Stubb recently told BBC there are an estimated 33 billion euro left in the current program, which facilitates the political approval process in the creditor countries.
Europe will find a way redeem or shift the imminent Greek liabilities versus the IMF and the European Central Bank to the European Stability Fund. For this purpose, it could use the unspent 10.9 billion euro from the Greek bank recapitalization fund, ECB profits from its Greek bond holdings, and/or allow Greece to borrow more short-term funds from its own banks. The means and the tools are certainly available – so why risk a global political mess at the IMF level?
At some stage in the above process, Greece should also be able to participate in the ECB’s quantitative easing program, with the redemption of the ECB-held bonds in July representing the earliest possible date.
Finally, under these conditions, Greece stands a chance of returning to nominal economic growth soon – the single most important factor that ensures sufficient generation of tax revenues, and hence the ability to service debts. Arguably, of course, the alternative option of a euro exit would also boost nominal growth – but it would also be a lot messier for Greece in the short-term, and accompanied by additional economic and geopolitical risks for Europe in the longer term.
The prospective accord on Greece is, of course, reaffirms the positive outlook for Europe as a whole, although that is neither new nor surprising. Nevertheless, it does further reduce the risk of setbacks in the region’s economic recovery path. In line with this view, the benchmark equity indices of Europe, and even more so in Greece, have rallied strongly since Monday. Greece has implemented hard austerity in recent years.
With regards to Greece’s economic situation, two elements are worth highlighting. The first is that it has already achieved a significant fiscal adjustment by reducing primary government expenditures faster and deeper than any other country in recent history, which is also why it’s GDP collapsed by about a quarter at the same time.
Spending cuts in the other countries were softer than in Greece. Spain actually even increased core spending since 2008, albeit probably not by as much as it would have otherwise (of course, Spain is not under any IMF program). However, the main point is that, unsurprisingly, nominal growth in all other countries has also recovered more quickly than in Greece – even before the launch of QE, the strong depreciation of the euro, and the fall in energy prices. Consequently, it is easy to see that Greek growth should also start rebound more quickly going forward.
Greece can return to its recovery path
The second point worth mentioning is that Greece had already entered a gradually but steady recovery path – it has probably passed its natural “bottom”. The next chart illustrates that some preconditions for a rebound are there in Greece. In fact, despite the politically induced setback since January, much of the economic data have actually held up relatively well, given the circumstances (e.g. uncertainty, deposit flight). Consumer confidence, for example, has been recovering from low very levels since 2011. It has remained volatile this year amid the political developments – but it is still higher than before the January election, for instance. A similar development can be seen in the “expected employment” index, which is based on a survey of Greek companies. That index recently reached positive territory for the first time since before the crisis. There is no reason why it should continue to climb again – as soon as a new agreement with the creditors removes key political uncertainties.