A rising tide lifts all boats, they say. The changing tide in Europe produced by the eurozone leaders’ decisions in Brussels on Friday could certainly help give Greece, sinking deeper into trouble over the last three years, the buoyancy it needs to survive.
Although still far from finalized, the outline deal that emerged somewhere around 4 a.m. in the Belgian capital paves the way for banks in eurozone countries to be recapitalized directly from the European Stability Mechanism (ESM), to which all members contribute money.
If this scheme applies to Greece, there are two key benefits. Firstly, it would reduce the public debt substantially. The current recapitalization of Greek banks involves 48 billion euros being lent to the government via the EFSF and this being distributed to the lenders via a public fund, the HFSF. This means 48 billion euros are being added to the national debt, whereas if the money is lent directly to the banks by the ESM, Greece would avoid this extra burden. Even after the debt restructuring (PSI) in March, Greece is still expected to owe just over 160 percent of its GDP at the end of the year. A direct recapitalization from the ESM would reduce this debt by about 25 percent of GDP. It would also slash the amount Athens pays in interest each year.
The 48 billion euros had been earmarked to cover the losses suffered by Greek banks due to PSI but the results of tests on local lenders by the Blackrock asset management firm are expected to show that a rise in non-performing loans – the result of the fiscal consolidation process on the economy – will mean more money has to be provided for recapitalization. If this is to come from the ESM, rather than via additional public debt, it will provide further savings for Athens.
Given that the aim of the troika-led fiscal adjustment program is to reduce Greece’s debt to about 120 percent of GDP by 2020, which the EU and IMF define as “sustainable”, recapitalization via the ESM would for the first time make this target even remotely possible.
This process would also avoid the internal complications that have held up the recapitalization. At the moment, there is consternation about whether private investors would come into the scheme or whether there would essentially be a nationalization of the Greek banks, handing control to the government and opening the lenders up to potential political interference.
What started off as a debt crisis for Greece has now become a liquidity and credit crisis. Healthy Greek businesses are being starved of cash and getting money to them so they can remain solvent, pay skeptical suppliers abroad and invest in the local economy is imperative. Avoiding any machinations involving Greek politicians and bankers that could undermine this process would be a distinct bonus.
However, it is by no means certain that the eurozone will allow the ESM to recapitalize Greek banks. The brief text of the agreement said the eurozone leaders “affirm that it is imperative to break the vicious circle between banks and sovereigns.” It refers to the Spanish and Irish banking sectors, not to the Greek. “The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment program,” the summit statement read, before adding the key phrase for Greece: “Similar cases will be treated equally.”
This can be interpreted as leaving the door open for Greece but only on the basis that its adjustment program is performing well, which it clearly isn’t at the moment. In response to a question from Athens-Macedonia News Agency about the phrase “similar cases”, Eurogroup chief Jean-Claude Juncker gave credence to this interpretation. “If Greece can find itself in a position like Spain or Italy [by meeting fiscal conditions], then of course the solution could be applied in Greece,” he said.
Given the momentous nature of the decision taken in the early hours of Friday, it is hard to understand why the Greek team was not moving heaven and earth to make sure there was an explicit reference to Greece in the leaders’ statement. A source who is familiar with previous Greek negotiations in Brussels suggested that the tentative agreement only came about as a result of German climbdown that nobody could have predicted. While this assessment rings true, it is also accurate to say that Spain and Italy had spent the run-up to the summit pushing very hard on the ESM recapitalization issue. It seems logical to expect the Greek delegation, especially as it was already without Prime Minister Antonis Samaras due to his eye operation, to have been prepared to take advantage of a best-case scenario, not just braced for the worst.
The first comment by a Greek official on the potential benefits of an ESM recapitalization came during the press conference of President Karolos Papoulias, filling in for Samaras, about 12 hours after the agreement was reached. The prime minister did not respond until the following day. Given that Papoulias was also joined by three ministers and a deputy minister in the Brussels delegation, it is worrying that quicker reflexes were not on display. Unfortunately, it is symptomatic of the lack of prescient, out-of-the-box thinking that has dogged Greece’s negotiations with eurozone and IMF officials over the past couple of years.
Until Friday, the coalition government was preparing to put forward a one- or two-year extension to the fiscal adjustment program, from 2014, as its main negotiating point in talks with the troika, due to start this week. It must change tack now. Having Greek banks recapitalized directly from the ESM must be the top priority. Asking for two extra years to meet fiscal targets would entail Greece having to borrow 16 to 20 billion euros more from the eurozone and IMF to cover funding gaps. There is no certainty its lenders would pony up and even if they did, Greece would be adding to its debt. This would require more fiscal adjustments in the future, simply to avoid taking some measures now.
The task of reducing, rather than adding to, the country’s debt must be embraced by the three-party coalition of New Democracy, PASOK and Democratic Left. The government had been hoping that the extra year or two of adjustment time would allow it to spread the 11.5 billion euros in savings the troika had wanted for 2013 and 2014 over a longer period. This might ease the pressure on the collapsing economy and make for a less politically volatile situation. However, there is an opportunity for Greece to combine the benefits of not bearing the debt burden of a recapitalization, creating some breathing space for the economy and providing the nascent coalition with a more politically manageable situation.
It is important to highlight at this point that even the troika has realized the detrimental effect that revenue-oriented measures had on the Greek economy. This is backed up by the numbers, which show the government is already 661 million euros short of its target for tax revenues so far this year. The new measures for 2013 and 2014 are focused on the expenditure side with the intention to rationalise public spending as a product of necessary reforms in public administration and the management of public finances. Greece has committed to savings of 1 to 2 percent of GDP from social benefits, a minimum 1 percent from government operations and 1 to 2 percent from pension spending focused on high pensions.
The troika wants Athens to achieve a primary surplus of 4.5 percent of GDP by 2014 (the latest program is designed on the basis of 1 percent of GDP primary deficit for 2012 and a primary surplus of 1.8 percent for 2013). Instead of wasting negotiating capital to extend the reform period, the government could strongly commit to the target of a primary surplus for next year and intensify its efforts to restructure the public administration, seeking higher savings there while negotiating down, to say 1 percent of GDP, the adjustment for social benefits and pensions, reducing the adjustment amount by approximately 4 billion euros for 2013 and 2014.
Through committing to primary surplus next year, Greece will end its dependency on financing government operations via troika funding. It will also remove flashpoints with the Europeans. It will force Athens to address the areas of wasteful spending and finally take ownership of the restructuring of the public sector, while displaying tangible evidence of commitment that will not short-sightedly focus just on personnel reduction. Ultimately, this will narrow the equally important credibility deficit that the Greek political system has brought on itself.
After five years of economic drought and three years in mired in the barrenness of austerity, the tide may be turning Greece’s way. The government must ensure the country is in a position to benefit from the new flow and not be left high and dry.
Nick Malkoutzis & Yiannis Mouzakis*
*Yiannis Mouzakis is an economics content specialist for a global content supplier. He blogs at Prodigal Greek.