By: LIN SEE-YAN . . . WHAT ARE WE TO DO? Saturday, 25 July 2015
Lessons from the harsh deal
NOBEL laureate Joe Stiglitz is right – the Greek debacle is “about power and democracy much more than money and economics.” Isn’t Europe all about democracy? So, why was the July 13 deal of preconditions to negotiate a third Greek bailout a total surrender? Indeed, it was a worse deal than the one Greek voters rejected in a referendum just two weeks earlier.
Greek hopes of ending brutal austerity lie in tatters. All the “red lines” drawn were crossed and Greece was committed to a programme the conservative predecessor would not have dared even consider. All because the Greeks dared to stick a finger in the eye of Europe.
In a nutshell, the “No” referendum vote turned disastrous – no Grexit (exit from Eurozone), but no to “no more austerity” either. Greece’s unsustainable high debt (at 323 billion euros or 177% of GDP) made the two objectives incompatible – just can’t have the cake and eat it!
With voters’ insistence on no Grexit, European creditors saw to it that “no more austerity” became unattainable – so much so Greece was bullied into paying the high political price of a raft of deeply unpopular harsh measures.
“The euro-family has been exposed as a loan-sharking conglomerate that cares nothing for democracy” (S. Moore, Guardian). As a result, its economy that was projected earlier to hit 2.9% growth in 2015 has plunged back into a severe contraction, even prolonged recession. It now has to seek an eventual EU bailout worth up to 86 billion euros in fresh funding over the next three years, and accepting much more cruel conditions to get it, including a 7.16 billion euro bridging loan to keep its finances afloat in the meantime, and up to 900 million euros of fresh European Central Bank (ECB) cash injection into the shuttered Greek banks to keep them open from July 20. ECB support now stands at a cool 130 billion euros.
Harsh deal: Yanis Varoufakis had likened the Brussels deal to the 1919 Versailles Treaty that imposed unpayable reparations on defeated Germany after WWI – Reuters
Debt relief
In the midst of the debacle, IMF (the International Monetary Fund) had warned: “The dramatic deterioration in debt sustainability points to the need for debt relief on a scale that would need to go beyond what has been under consideration to date – and what has been proposed by Eurozone authorities.”
As I understand it, Eurozone would only later consider debt maturity extension and rate reduction once Greece delivered as promised. This option of even “a very dramatic extension of Greece’s debt will bring about an unsustainable debt dynamic for the next several decades” (IMF). Moreover, failure by Eurozone to provide stronger commitment on restructuring could prohibit IMF participation (by its own rules) in the bailout.
“Other options include explicit annual transfers to the Greek budget or deep upfront haircuts,” both of which are ruled out as a political non-starter by euro-hawks such as Germany. All this is most sobering. It simply points to continuing high downside risks.
The deal
The deal was Greece’s least-worse choice, reflecting its poor relationship with Europe which has eroded trust and mutual respect. It doesn’t provide for debt relief which the nation so desperately needed. It just sets Greece up for more traumas ahead. It appears, however, that Germany and other creditors have managed to exact severe punishment on the left-wing government on the pretext that “trust needs to be restored” (Merkel).
Sure, Greece urgently needs many of the reforms in this deal, especially overhauls in pension (consume 16% of GDP), including cutting special payments and raising the retirement age to 67. To avoid deep spending cuts, taxes will be raised – corporate taxes to 28% and VAT, up immediately to a uniform 23%. It forces labour reform, bringing long-awaited relief to employers (from strict limits on overtime to generous vacation and severance) and making it easier to fire workers, as well as liberalising product markets (including working Sundays).
The deal created a 50 billion euro fund (under European supervision) from state-owned assets slated to be privatised or wound down. Monies raised will be used to service debt and help create a “buffer” to re-capitalise its “broken” banks, not to promote growth. It imposes intrusive monitoring and micro-management by EU and IMF.
The hard part
Implementation will be extraordinarily difficult and uncertain – amplified by deteriorating social conditions. Greek GDP had shrunk by a quarter over 5 years. Unemployment is at 27% and youth unemployment over 50%. Partly to blame is austerity imposed in the early years, seeking to lower the budget deficit too far too fast. Since then, the drama has become desperate. Having suffered a severe fall in output and living standards, Greek society now faces new hardships. The financial challenges include successfully re-opening banks that have suffered much balance sheet damage.
Huge deposit withdrawals have been funded by ECB’s Emergency Liquidity Assistance (ELA). The assets side is eaten up by non-performing loans and dubious bond holdings. They all raise doubts about bank solvency. ECB has since agreed to ease the funding squeeze by providing further access to ELA liquidity. Also, EU has granted new bridging funds to meet immediate debt servicing. All this with the realisation that Greece’s existing stock of debt is already unsustainable.
Tough lessons
The country of Plato has turned tragic. Chancellor Merkel had warned that the path back to normalcy and growth would be long and arduous. Greece will be kept afloat within the Eurozone so long as Athens followed through on the deal. The prospect of Grexit remains.
As I see it, Greeks are right to demand less austerity through more debt relief. Asphyxiating fiscal targets have led to prolonged economic ruin. The new deal is set to perpetuate the experience of the previous two bailouts, with only a slim prospect of debt relief. Worse, European creditors appear to have repeatedly displayed indifference towards popular sovereignty when they steamrolled over most of Greece’s pre-election promises and ignored Greek political realities.
Prof Y. Varoufakis had likened the Brussels deal to the 1919 Versailles Treaty that imposed unpayable reparations on a defeated Germany after WWI. This contributed to deep instability in Germany and indirectly, to the rise of Hitler in 1933. After WWII, Germany was the recipient of vastly wiser US concessions, culminating in significant debt relief in 1953, an action that greatly benefited Germany and the world. Yet Germany has failed to learn the lessons from its own history. It is time for statesmanship to return for the sake of Europe’s future generations.
What then, are we to do
Lesson One: Negotiation with a firm democratic mandate is not enough, when the other side represents voters too, who never signed up for large unconditional transfers.
Lesson Two: Creditors must avoid overreach; but they will not be cowed into subsidising endless delinquency because they believe that for the system to work, it must have discipline.
Lesson Three: Negotiations in desperate situations critically require trust and mutual respect. Once broken down, settlement terms harden and the “accountant” in the creditors’ psyche takes over. Pride can only be reclaimed by the debtor through patience and humility in the complex reality of a very messy and bruising situation.
Lesson Four: The moment a nation starts looking for money, it is already in a bad negotiating position. As the Greek prime minister had admitted: “I acknowledge the fiscal measures are harsh, that they won’t benefit the Greek economy, but I’m forced to accept them.” The alternative is disorderly bankruptcy that will be really catastrophic. The 1997/98 Asian crisis taught nations to build lots of reserves to secure sufficient policy degrees of freedom to avoid precisely such a “Greek situation.”
Lesson Five: Europe needs to reconnect with ordinary citizens; a greater sense of inclusion is required. There is certainly a sense of disconnect and disenfranchisement across the continent.
Lesson Six: Today, the world is suffering from an overhang of debt – since 2007, total public debt in advanced economies rose by a significant 35 percentage points of GDP (up 47 points in Italy, 63 in Japan and 83 in Portugal). Nations can get out of this through: austerity, growth and low interest rates or default. More common than appreciated is to restructure, including hair-cuts. Best is to reform early enough. Most toxic is high debt and low or no growth; or high debt and austerity with little growth. A better situation is to have borrowed mainly in one’s own currency – hence, no need to default since it can print money on the way out. Least painful is via economic growth. Unfortunately, potential growth around the world is now slipping.
So, the decent way out is to take a balanced combination of growth, austerity and punitively low interest rates. Even so, without hair-cuts, it will take a very long time – up to 40 years, by one estimate.
Whatever the outcome, European risk is rising as markets find it increasingly difficult to price in such risk. Financial contagion from Greece is not of concern.
Greece accounts for just 1.8% of Eurozone GDP and 0.3% of the global economy. But its political punch is powerful whether or not Greece remains in the Eurozone – a risk investors can’t ignore.
So, hold a little more cash and be a little more cautious in the second half.
- Former banker, Harvard educated economist and British chartered scientist Lin See-Yan is the author of ‘The Global Economy in Turbulent Times’ (Wiley, 2015). Feedback is most welcome; email: starbiz@thestar.com.my.
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