greek choices after the elections: is exit an option?

 AnalysisNo.281, January2015
GREEKCHOICESAFTERTHEELECTIONS:
ISEXITANOPTION?
ZsoltDarvas
©ISPI2014 InthedaysaheadoftheGreeksnapelectionson25January2015ahugerangeofopinionshasappearedon
what Greece and its lenders should do. A large group of people are saying that Greek public debt is
unsustainableandasignificantpartofitshouldbewrittenoff.Intheirview,theTroikaisresponsibleforthe
deepcrisis,austerityhasfailed,andthefiscalspacegainedfromthedebtwrite‐offshouldbeusedtostimulate
growth.
ZsoltDarvasisSeniorResearchFellowatBruegel,ResearchFellowattheInstituteofEconomicsoftheHungarian
AcademyofSciencesandAssociateProfessorattheCorvinusUniversityofBudapest.
1
Le opinioni espresse sono strettamente personali e non riflettono necessariamente le posizioni dell’ISPI.
Le pubblicazioni online dell’ISPI sono realizzate anche grazie al sostegno della Fondazione Cariplo.
Some opinions say that irresponsible pre-crisis Greek policies, as well as
the extremely large, 15% of GDP budget deficit in 2009, necessitated the
bail-out in 2010. Implementation of the bail-out conditionality was
incomplete and the Geek public sector is so inefficient and so much
depends on cronyism that it is not surprising that the Greek crisis became
so deep. As always, both sides have some truths but none of these
explanations is complete. One could write a lot on what happened, who is
responsible for desperate social hardship and what should have been done
differently. But after the elections, both Greece’s new leaders and
euro-area partners should look ahead: given the status quo, what are the
real choices?
Exit is not an option. Greece would enter another deep recession, which
would push unemployment up further and reduce budget revenues,
requiring another round of harsh fiscal consolidation: exactly what
opposition parties want to avoid. (This effect is forgotten by those who
argue that since Greece has a primary budget surplus, it has now the
option to default and exit). Euro-area creditors would lose a lot on their
Greek claims and private claims on Greece would also suffer (see our
earlier post here1). Moreover, exit would also risk the stopping of
EU-budget related inflows to Greece (cohesion and structural funds,
agricultural subsidies): in 2013 Greece received a net payment of 2.9 per
cent of GDP from the EU budget. This was a transfer (not a loan) and the
country would receive similar transfers in the future too. Debt write-down
is extremely unlikely – and unnecessary as well. Any level of debt is
sustainable if it has a very low interest rate. Japan is a prime example:
gross public debt is almost 250 % of GDP, while the average interest rate is
0.9 per cent per year. Despite the very high Japanese public debt, there is
no talk about its restructuring.
©ISPI2014 Loans from euro-area partners to Greece carry super-low interest rates
and also have very long maturities. The lending rate from the European
Financial Stability Facility (EFSF) is a mere 1 basis point over the
average borrowing cost of the EFSF, which is around 0.2 per cent per year
currently. The average maturity of EFSF loans is over 30 years with the
last loan expiring in 2054. Moreover, in 2012 the Eurogroup2 agreed on a
deferral of interest payments of Greece on EFSF loans by 10 years,
implying zero cash-flow interest cost on EFSF loans during this period.
The interest rate charged on bilateral loans from euro-area partners is
Euribor plus 50 basis points, which is currently about 0.56 per cent per
year: another very low value (which could be lowered further, as we
1
http://www.bruegel.org/nc/blog/detail/article/1542-why-a-grexit-is-more-costly-for-
germany-than-a-default-inside-the-euro-area/
2
http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/133857.pdf
2 argued here3). Bilateral loans have a long maturity too: they should be
gradually repaid between 2020-2041.
One can say that yields will not remain so low forever and if ever growth
and inflation will pick up in the euro area, interest rates will increase.
Unfortunately, this is in the distant future and therefore the cash-flow
gain for Greece from stopping interest payments to euro-area partners
would be very low in the next few years.
In fact, according my calculations, one of the demands of Syriza leader
Alexis Tsipras4 will be likely met this year, even without any change in
bail-out terms: actual interest service costs of Greece will likely be below 2%
of GDP in 2015. Table 1 shows the situation in 2014. Total interest
expenditures of Greece amounted to 4.3 % of GDP. However, interest paid to
the ECB and euro-area national central banks (NCBs) is returned to Greece
(if Greece meets the conditions of the bail-out programme) and interest
payments on EFSF loans are deferred. If we subtract these, interest
payments were only 2.6% of GDP in 2014, well below the values of other
periphery countries. Given that interest rates have fallen significantly from
2014, actual interest expenditures of Greece will be likely below 2% of GDP
in 2015, if Greece will meet the conditions of the bail-out programme.
©ISPI2014 TABLE 1 - Interest burden on public debt in 2014
Note: end-2013 value for gross public debt, 2014 value for interest payments.
ECB=European Central Bank. NCBs=national central banks. EFSF=European
Financial Stability Facility. Greece receives from the ECB/NCBs both the
interest it pays on their Greek bond holdings and the capital gains of the central
banks from Greek bonds (most of the bonds were purchased below face value).
In my calculation I only excluded the interest component. Source: the first two
data columns are from the November 2014 forecast of the European Commission;
the third column is my calculation.
3
http://www.bruegel.org/nc/blog/detail/article/1533-how-to-reduce-the-greek-debt-burden/
4
http://www.reuters.com/article/2014/12/18/greece-vote-tsipras-idUSL6N0U24E020141218
3 Since the actual debt servicing cost of Greece is low, it is extremely
unlikely that parliaments and governments of euro-area lending countries
would decide to cancel their Greek loans and raise taxes at home to cover
the losses.
Maturity extension and further cut in interest rate: yes. While euro-area
loans to Greece already have extremely long maturities, further extension
is possible. Whether the average maturity is 30 years or 40 years, there is
not a big difference. Moreover, the 50 basis point spread over Euribor,
which is charged on bilateral loans, can be abolished without leading to
direct losses to euro-area partners. As was argued with Pia Hüttl5, such
changes would imply a 17 % of GDP net present value gain for Greece over
the next 35 years. While this would not be an upfront funds that could be
spent, on average the primary surplus of Greece could be about 0.5 % of
GDP lower in the next 35 years, which is sizeable.
A new financial assistance programme: yes. As we argued with Andrés
Sapir and Guntram Wolff 6a year ago, a third programme should be put in
place to take Greece out of the market until 2030. Even if the currently
very high market interest rates for Greece will fall, they will likely remain
too high.
©ISPI2014 Easing fiscal policy: perhaps. In our paper with Sapir and Wolff we also
argued that the new programme should be accompanied by enhanced
budgetary commitments by Greece, whereby Greece should reach a
balanced budget by 2018. Hoverer, due to the fall in interest rate and an
improvement in economic activities (2014 was the first year with modest
economic growth, with 2-3 per cent growth expected for 2015), in November
last year the Commission forecast a balanced budget already for 2015,
despite a forecast decline in structural primary surplus (Figure 1). In fact,
the expected decline in the structural primary surplus would imply fiscal
easing and therefore the expected improvement of the actual primary
balance (red line of the figure) is expected to come mainly from the
improved economic situation. If the maturities of euro-area loans to
Greece are lengthened and the 50 basis points spread on bilateral loans is
scrapped, the primary surplus could be reduced by an additional half
percent of GDP. Therefore, there would be some room for manoeuvre to
ease the social pain and to help growth with some public investment.
5
http://www.bruegel.org/nc/blog/detail/article/1533-how-to-reduce-the-greek-debt-burden/
6
http://www.bruegel.org/publications/publication-detail/publication/816-the-long-haul-
managing-exit-from-financial-assistance/ 4 FIGURE1 - Primary budget balance of Greece, % of GDP, 2003-2016
Note: the primary balance is the budget balance excluding interest payments.
The structural primary balance is the estimate of the underlying position of the
primary balance, by excluding the impact of the economic cycle (such as the
negative impact of recession on tax revenues) and one-time revenue and
expenditure measures (such as bank rescue costs). Source: European
Commission forecasts: the November 2014 forecast includes data on the
structural balance from 2010 onwards, for earlier years we used the May 2014
forecast.
Structural reforms: yes. Even Syriza argues that Greece needs major
structural reforms. Yet it may be difficult to find an agreement between
Greece and the Troika, because many of the current plans of the Greek
opposition parties are in diametric opposition to reforms agreed under the
financial assistance programme. But a compromise has to be found: both
sides have strong incentives to agree and structural reforms have to be
part of the comprehensive agreement.
©ISPI2014 A European boost to economic growth in the euro-area periphery: should
be yes, but low hopes. With Sapir and Wolff we also argued for the need for
European support to growth throughout the euro-periphery. While I
continue to think that there would be a strong rationale for it,
unfortunately I see little political reality.
European assurance for Greece against adverse shocks: yes. Even if
Greece will cooperate with euro-area partners and will fulfil its
commitments, such a high debt ratio is sensitive to adverse risks, like
weaker growth, lower inflation or higher interest rates. Therefore, some
sort of European assurance is needed for Greece to eliminate the
uncertainty over Greek debt, if Greece meets loan conditions. Otherwise,
the uncertainty may deter the investment climate, even if euro-area loans
5 have super-long maturity and low interest rates. One option would be
to index official loans to Greek GDP7 as I suggested in a 2012 paper.
Thereby, if the economy deteriorates further, there will not be a need for
new arrangements, but if growth is better than expected, official creditors
will also benefit. Another option would be to commit on the part of lenders
to reduce loan charges belowtheir borrowing costs, should public debt
levels prove unsustainable despite Greece meeting the loan conditions (as
we argued with Sapir and Wolff).
What are the chances for such a comprehensive agreement which could be
claimed as victory by both sides? I think it is higher than many
commentators think, for two main reasons.
First, lack of an agreement may lead to Grexit, which would be so bad for
all that both the new Greek leadership and euro-area partners have very
strong incentives to avoid it.
Second, there are some reasonable options to agree on the reduction of the
debt burden and easing fiscal policy, as I outlined above. Thereby, the new
Greek leadership could claim that it achieved a major reduction in the cost
of debt service and got some fiscal space to ease the social pain and boost
growth, while European partners could tell their people that they only
extended the loan maturities and eliminated the gap between their own
borrowing costs and their lending rate to Greece, thereby taxpayers
should not suffer loss.
©ISPI2014 Certainly, negotiations may not work out nicely. We do not know yet if a
government will be formed right after the elections, or a new election will
be needed later; Greece may run out of time. When a government is
formed, negotiations could be suspended, perhaps repeatedly, which would
create further uncertainty. Such uncertainty would lead to deposit
withdrawal from Greek banks and deteriorating economic and fiscal
outlook. Some euro-area partners may say no to certain parts of the
agreement even if other euro-area partners agree. Some members of the
new Greek parliament mas say no even if the new government and most of
its parliamentary members are in support. I may have also incorrectly
assumed that the responsible decision makers think rationally. Therefore,
there could be many pitfalls for an agreement, yet the Grexit threat will be
hanging over the negotiators like the sword of Damocles.
7
http://www.bruegel.org/publications/publication-detail/publication/759-the-greek-debt-
trap-an-escape-plan/
6