Monica Defend, head of Global Asset Allocation Research and Andrea Brasili, senior economist Global Asset Allocation Research comment on Greece’s crisis recent developments
How are the bailout negotiations progressing?
Headlines report that Greece has reached an agreement with creditors on a €86bn bailout.
At the time of writing, talks are still private and no details are available; the agreement will probably include actions that Greece must pass immediately plus more measures to follow in October.
Once Athens and several European Governments pass the proposals, the ESM would be in the position to disburse the first tranche of the loan before August 20, when the €3.2bn debit with ECB
What are the major open issues around the agreement?
The main open issues are how much debt relief will be incorporated as part of any agreement, and what form it will take.
The IMF (International Monetary Fund) is strongly arguing for broad action on debt. The Fund published an updated DSA (Debt Sustainability Analysis) on June 26, and a brief but toughly worded further update on July 14.
Here the IMF explicitly said: “Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far.”
What has changed in recent weeks is that the health of both the Greek banking system and economy has deteriorated.
Financing needs are higher because there is an immediate need of intervention in support of the banking system, and GDP growth will be much lower this year and next year.
Considering the new financing needs, IMF estimated debt/GDP ratio could be around 200%, a threshold that the IMF considers as a sure “damnation”. The conclusion is clear according to the IMF, i.e., a huge debt relief package is needed. This could take the form of a dramatic lengthening of maturities (at least 30 years).
On its side, the EU Commission released an assessment of the Greek request that also analysed, among other things, debt sustainability. It highlighted in a similar vein the worsening of the situation since last year, albeit with a less negative tone than the IMF.
The UK based National Institute of Economic and Social Research (NIESR) recently concluded that in order to put Greece on a sustainable path and avoid permanent recession its debt should be cut by some 55% of GDP.
But Germany and other creditor governments have so far strongly resisted any suggestion of forgiving Greece’s debts.
Are there reasons for hope?
The key point here, we believe, is with respect to the prospects for growth. The IMF notes that assumptions implying, after some years of transition, a primary surplus at 3.5% (forever) and productivity growth that goes from being the worst in Europe to the best risk being overly optimistic.
Nonetheless, a growth rate of 1.5% forever does not seems out of reach. An interesting work just released by Brussels-based think tank Bruegel highlights how the dissatisfaction with the Greek programmes is related to delays in the implementation of reforms, based on a review encompassing the period 2000-2014.
While Portugal and Ireland offer examples of programmes on track, Greece’s implementation has seen major setbacks, due to political instability.
However, it would not be entirely fair to say that Greece has not delivered in terms of reform: for example, looking at the World Bank Doing Business ranking, Greece has recorded similar progress to that of Portugal in the past 5 years. However, as a result of both delays in implementation and the design of the programmes themselves, this timeframe has not seen a return to growth.
If a new programme for Greece is designed with a return to growth as a primary objective, things could surprise on the upside. Think of the rebound experienced in Spain (still ongoing) after the full repair of the banking system.
And consider as well the fact that one of the puzzles regarding Greece, the apparent insensitivity of its exports to declining labour costs, started to respond positively in 2014.
It is quite possible that, once the uncertainty seen so far in 2015 is finally resolved and the banking system begins to again work properly, exports will see further progress.
To answer the question: Greece is not yet a lost cause, rather, it is a laboratory for Europe of economic and institutional policy. There is indeed reason for hope, but the outcome remains uncertain.