What does the eurozone deal really mean for Greece?

Illustration by Manos Symeonakis

The European Commission announced this week that it’s prepared to provide 95 percent of the funding for structural projects in Greece. Members of an EC task force are due to arrive in Athens later this month to oversee the implementation of reforms. Ministers, meanwhile, are trying to put together legislation that will convince Greece’s lenders that it is taking its role seriously.

In one way or another, these actions all stem from the deal agreed between the eurozone and Greece in Brussels last month. Even though the agreement has set in motion such a wide-ranging process, there is still great uncertainty about what the agreement on July 21 actually means for all those involved and how it will benefit Greeks. There is a sense that Greece and its eurozone partners are trying to navigate through a storm with a patchwork map and some untested instruments to help them.

“Greece mostly gains time because it has now been completely excluded from financial markets for the foreseeable future,” Costas Lapavitsas, a professor of economics at the University of London’s School of Oriental and African Studies, told Kathimerini English Edition. “But time alone does not fix things.”

Despite all the conjecture, though, there were certain tangible aspects to the 159-billion-euro Brussels agreement. Firstly, the eurozone is willing to continue providing Greece with the loans it needs for as long as it is locked out of the markets. This, of course, means that Athens has to continue to meet the fiscal targets set by its lenders. Although there is no guarantee that this will happen between now and mid-2014, the give-and-take process was established by the first loan agreement, or Memorandum.

“Greece gains time, a somewhat eased debt burden and, perhaps most importantly, the political signal that other EU members recognize that too much was being asked of Greece,” says Iain Begg, a professorial Research Fellow at the European Institute of the London School of Economics and Political Science.

The positives for Greece are that the new loans, which amount to 109 billion euros, will come with lower interest. The first package began with a rate of about 6 percent but the new money will be borrowed with interest of 3.5 percent. The repayment period will also be longer: 15 to 30 years, rather than 7.5. But that’s round about where the givens end and the variables begin.

Seeing the crisis grip Spain and Italy, whose borrowing costs reach record level this week, European Commission President Jose Manuel Barroso suggested on Thursday that the July 21 package had been undermined by “undisciplined communication, complexity and incompleteness.” It seems Greece will find it difficult to dispel these shortcomings.

A number of question marks hang over the involvement of the private sector in the second rescue package for Greece. Finance Minister Evangelos Venizelos hopes to have ready by the middle of this month Athens’s proposals for private sector bondholders, who may be willing to contribute up to 50 billion euros. Banks are likely to be offered four options — three bond exchanges and a rollover into debt with maturities of up to 30 years — alongside a scheme to buy back Greek government bonds. The process is set to lead to banks taking a 21 percent loss on bonds maturing by 2020 but their participation will be on a voluntary basis.

“The Achilles heel [of the package] is the voluntary nature of the exchange options and the fact that it has to be negotiated,” says Jens Bastian, a senior economic research fellow at Athens-based think tank the Hellenic Foundation for European & Foreign Policy (ELIAMEP). “Both elements imply that you have the option to refuse or withdraw and to drive a hard bargain.”

Many experts believe that lenders are getting off far too lightly in comparison to taxpayers. “The summit should have made up its mind to go for a much more drastic haircut and should have made banks’ participation really binding,” Ansgar Belke, an economics professor at the University of Duisburg-Essen and a research director at the Berlin-based German Institute for Economic Research, told Kathimerini English Edition.

In fact, he suggests that banks are getting a much better deal than they might have expected. “The market value of Greek bonds is currently about 50 percent below their nominal value, whereas the effective haircut only amounts to 21 percent. The banks have already written off losses of this magnitude in their trading and even their banking books. They are thus able to conduct even upward value adjustments as a consequence of the summit agreement.”

Furthermore, of the 109 billion euros Greece is due to receive in loans, 20 billion will have to be invested in top-rated AAA bonds to be used as collateral in the swap deal with lenders. Another 20 billion euros will be used to recapitalize Greek banks, which are the biggest holders of Greece’s sovereign debt. All in all, this represents a nice piece of business for the lenders, argues Lapavitsas.

“Banks got off exceptionally lightly. The deal was indeed structured by banks and hence they minimized the costs to themselves. They have also gained new credit-enhanced securities, secured liquidity and obtained guaranteed of recapitalization.

“There appears to be no concept of moral hazard when it comes to lenders, among European policymakers at least.”

The contentious involvement of the private sector feeds into another controversial aspect of the Greek rescue package, which is that — in the short term at least — it will add to the country’s debt mountain. As several analyses have shown over the past few days, although the bond swap is designed to reduce Greece’s debt, its effect will not be felt for some time.

Charles Forelle of the Wall Street Journal explains it as follows: “The bond exchange will swap 135 billion euros of old Greek debt for 121.5 billion in new debt, cutting the total debt stock by 13.5 billion. But first, Greece must borrow money to fund the purchase of collateral that backs the newly exchanged bonds. That new borrowing more than offsets the savings. In all, we estimate that the exchange means the debt stock will rise by 18 billion euros by the end of 2011.

“Of course, Greece will have an offsetting financial asset (the collateral) but the rules used by the EU to compute debt ratios rest on a definition of gross debt, not debt reduced by the value of assets, financial or otherwise. And, decades hence, Greece will get to liquidate the financial asset to repay debt, with a corresponding drop in the debt stock.”

Forelle’s calculations mean that Greece could be looking at a debt of 370.6 billion euros, or 164.7 percent of GDP, next year. Reuters Breakingviews columnist Hugo Dixon estimates that the bond swap will lead to Greece’s borrowing increasing by 31 billion euros, leading to its debt reaching a staggering 179 percent of GDP. Given that most economists agree that the debt-to-GDP ratio needs to be below 90 percent to be sustainable, it is clear that Greece will face an even more Herculean task than it envisaged.

Lapavitsas describes the process of burdening Greece with more debt as an “absurd thing to do.” Belke says the absence of a bolder move to reduce Greece’s debt means that a further assistance package for Athens is inevitable.

“Although parts of the agreement point in the right direction, the extent of the concrete measures decided is disappointing,” he said. “They do not have the potential to put an end to the debt crisis. Instead, the risk of contagion of other countries will increase. This is because the much too low haircut sends the message to the market participants that an even more significant restructuring, if not a more gigantic transfer from euro-area countries to Greece, will be necessary and will take place in the near future.”

The German economist believes that the transformation of the European Financial Stability Facility (EFSF) into the more potent European Stability Mechanism in two years’ time will lead to the eurozone taking another look at what it can do with Greek debt.

“Presumably, we will see an even more substantial debt restructuring after 2013 when the EFSF will be substituted by the ESM and the German elections will have taken place.”

Bastian agrees that given the current conditions, which include an economy that shrank by 4.5 percent last year, it is almost certain that further action will have to be taken to reduce Greece’s debt. “In my view these debt exchange, rollover and debt buyback options are a precursor for a second restructuring arrangement two or three years down the road, if and when debt sustainability does not prevail because of lacking GDP growth, continued revenue collection problems and high unemployment,” he told Kathimerini English Edition.

One part of the Brussels package seeks to address the growth issue through what eurozone leaders referred to in their statement as “a comprehensive strategy for growth and investment in Greece” or a new Marshall Plan, similar to the US-backed aid program that kicked in after the Second World War.

“I would rather call it a Hercules Plan,” said Bastian. “It is significant for two reasons. Firstly, it acknowledges that Greece needs an investment perspective that was sorely missing from the first Memorandum with the troika. Secondly, it puts the focus on Europe’s shared responsibility to confront Greece’s deep underlying administrative and regulatory deficits.”

The European Commission confirmed this week that it will increase its share in the co-financing of structural projects in Greece from 73 percent to 95 percent as part of the effort to “relaunch the Greek economy.” Greece has so far only claimed some 5 billion euros of 20.2 billion available, mostly for infrastructure works, between 2007 and 2013 through the EU’s National Strategic Reference Framework Scheme. The slow pace is partly due to the bureaucratic holdups in granting approval for funded projects. More than 4,700 schemes are currently awaiting approval, according to the government.

This is one of the reasons for the Commission sending its own task force — to be headed by Horst Reichenbach, vice president of the European Bank for Reconstruction and Development — to Greece to oversee the reforms the government has promised.

However, Lapavitsas says that unless overall economic policy — focused on public spending cuts, tax hikes and reducing salaries — in Greece changes, then the situation is unlikely to improve.

“There has been no real change with regard to austerity and raising the competitiveness of the Greek economy through internal devaluation,” he said. “This is the major weakness of EU policy.”

According to Belke, for the investment program to have any positive effect, the underlying structural conditions, which act as barriers to growth, will have to be overcome first.

“The starting point of any consideration of a Marshall Plan-like investment boost in Greece should be the diagnosis that Greece does not suffer from a lack of infrastructure but from private, public and foreign over-indebtedness and a huge lack of competitiveness. What is more, conditions of efficient investment have to be improved before investment itself is given a strong boost.”

Belke says it is a fallacy that the countries, including Greece, Sweden and the UK, which benefited from US funding after the Second World War, saw quicker economic recovery than Germany and Italy.

“Much more important for the German way out of the mess after WWII was deregulation of price controls under [Chancellor] Ludwig Erhard,” he said. “This pattern again emphasizes the importance of improving the institutional environment before one should go for a boost of investment.

“A classical infrastructure program as was conducted in East Germany two decades ago is simply not necessary in Greece. More promising is a transfer of technical assistance in areas such as privatization schemes and efficiency programs for the public administration — such as tax offices and the land registry — and administration of EU funds.”

Belke suggests that among those who stand to benefit most from a new Marshall Plan are German firms with an eye on making strategic investments in Greece.

“German firms are interested in a bridgehead partner country with competitive wages and a sound institutional infrastructure for trade with the Far East via the Suez Canal,” he said.

All of which brings us back to the original question of how the deal agreed in Brussels last month will benefit Greece and its people. This, it seems, is an issue shrouded in uncertainty, which is a feeling that Greece and the eurozone are rapidly becoming used to.

Nick Malkoutzis

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