Can Greece’s rescue plan succeed?

Athens, Greece – Germany’s election means something to almost everyone in Europe. To the Greek street, it signals the point when the government ought to pluck up the courage and ask the Eurozone to forgive a big chunk of its onerous debt, which now stands at 174 percent of its GDP.

Four years of austerity have succeeded in eliminating a $49bn budget deficit even while the economy shrank – a painful process akin to playing the piano while someone breaks your fingers. Having done this, Greece finds that its economy has shrunk so much, it is barely able to service its debt. Interest last year cost $16bn, placing the country in what one economist calls a “debt bondage”.

The debt also acts as a barrier to growth, creating a vicious cycle. “No-one wants to invest in a country which is uncertain, which has lost confidence, which is shrinking,” says former finance minister Nikos Christodoulakis. Apart from the risk, there is the reality of high taxes.

Angela Merkel’s government has lent the Greeks money on the principle that German taxpayers will never have to pay for the European periphery’s debts, so it seems that the Greeks will be disappointed in their quest. The problem is that most Greek economists no longer see the country’s rescue package as viable without serious intervention.

“It is highly doubtful whether this rate of tax extraction from a moribund economy can be maintained,” says Athens University economist Yanis Varoufakis. He is admittedly one of the Greek rescue plan’s most severe critics, and has predicted that the euro will ultimately meet its Waterloo in Greece.

Varoufakis is not alone, however. “You need fresh money in this country,” says Gikas Hardouvelis, a proponent of the Greek rescue. As chief economic advisor to Prime Minister Loukas Papademos, he played a leading role in negotiating Greece’s second facilitation loan last year. “Otherwise we’re going to lose our youth, the country is going to shrink and we’re going to be taken over by foreigners.”

Competing visions

Merkel’s opponent in Germany’s election on Sunday election, Social Democrat leader Peer Steinbrueck, espouses the idea of a massive investment package for the European periphery – a second Marshall Plan; but his party is trailing the ruling CDU in the polls by about 10 points.

Greece was essentially bankrupt when it lost the ability to borrow affordably from markets in early 2010. It accepted some $300bn in facilitation loans from the European Commission, the European Central Bank and the International Monetary Fund – the notorious ‘troika’ – who feared a collapse of the euro as a currency should Greece be allowed to fail like a massive Lehman Brothers. In return, Greece had to commit to painful spending cuts.

The result of austerity is that the economy has lost 26 percent of its size and is still shrinking. Unemployment is the highest in Europe at 27.9 percent, and twice that for the young. Wages have fallen sharply for those who still work – by about 23 percent in the private sector and as much as twice that in the public sector.

Prime Minister Antonis Samaras put a brave face on things in an annual economy speech earlier this month. “Greece is turning a new leaf. Its economy, after six years of recession, is turning a new leaf,” he said, predicting recovery in 2014. The government is claiming to have finally reached a budget surplus before debt servicing is factored in. It also sees a lower-than-predicted recession in the second quarter (-3.8 percent instead of -4.6 percent) as heralding the beginning of an upturn to growth.

The government has been quick to grasp at straws before. In late spring, Samaras foresaw unemployment stabilising. In January his finance minister, Yannis Stournaras, foresaw a return to growth by the end of the year. Both predictions were confounded. Could this time be different?

Greek economists think not. They are deeply sceptical about the primary surplus, attributing it to the government withholding payments to private sector suppliers and Value Added Tax returns to businesses, and allowing the social security deficit to widen.

They converge on the view that the recession is slowly lifting, but that this merely leaves the economy moribund. “A starving person sheds a large portion of his weight in the first few weeks. As death approaches, the rate of weight diminution declines to zero,” says Varoufakis dryly.

When $140bn of Greek debt was written off in March 2012, there was an optimistic camp, which felt that Greece’s finances were going to be sustainable. That camp is now deserted because financial markets still won’t touch Greece.

At the very least, analysts expect Greece to be given another reduction in interest (it has already fallen from five percent to 3.1 percent) and an extension on the maturity of its loans. But this is merely to prevent a collapse in instalments.

Growth is a more elusive goal. The Greek banking system cannot finance it because it is itself bankrupted by the level of nonperforming loans. Two years ago the government brought in the financial consultants Blackrock to audit the banking system. “Blackrock found that about 30 percent of loans were nonperforming in 2011. Now it might well find twice that proportion,” says Christoforos Sardelis, who created Greece’s Public Debt Management Agency in 2000, and now works at the National Bank of Greece.

Five ways out

Austerity has led to such a massive sapping of public and private wealth that the recovery has to come from outside, most Greek economists say. Their ideas fall into two categories – those that reduce debt and those that would bypass it to nurture growth.

“I think the eventual solution for the Greek debt problem will be some form of debt-equity swap,” suggests Hardouvelis. “We owe at this stage over $288bn to our European partners, and everybody is asking how to get rid of that wolf that scares investors. The best way to do it is to say, ‘let’s swap debt for equity, and come in and invest’. Land is the easiest thing to do… take a rocky island for 100 years… I don’t see any other solution.”

The idea of mortgaging sovereign territory to Germans might be politically controversial, but it kills two birds with one stone, generating revenue and reducing debt at the same time.

Christodoulakis suggests a different kind of swap between Greeks and Germans. Germany coerced two loans out of the Bank of Greece in 1943, during the Nazi occupation. These were never repaid, and Christodoulakis estimates their current value with interest at over $21bn – roughly, he says, Germany’s contribution to Greece’s first facilitation loan in 2010.

“I think that a very fair compensation and settlement of the issue would be to count one for the other… It would reduce the amount of Greek debt by 8-10 percent of GDP.” This idea enjoys overwhelming popular support in Greece, but has been ruled out by Germany.

Sardelis focuses on growth. He believes that a “risk transfer” to an internationally recognised body would unlock liquidity to the south.

“The European Investment Bank or the European Central Bank or some other institution needs to take on the role of loan guarantor. That would enable [banks] to issue loans to the peripheral economies on looser terms,” he says. “When trust breaks down someone intervenes and restores it. This isn’t happening,”

A path to growth?

Left-of-centre economists focus on how Greece might regenerate itself without a wealth transfer from the outside. Savvas Robolis, who heads the Labour Institute, believes that Greece could generate half a point of GDP and seven thousand jobs just by restoring the minimum wage to 751 euros ($1014) a month. A controversial law in February 2012 lowered it to 586 euros despite protests from the Greek business community that taxes and state bureaucracy were a far more pressing concern. Unemployment has continued to rise, suggesting that the measure was far from successful.

Varoufakis doesn’t think Greece can recover if it attempts to service its debt while it remains in recession. “Greek debt will remain sky high while Greece’s GDP will continue to shrink,” he says. He believes a new contract between Greece and the troika should make Greece’s repayment schedule “dependent only on Greece’s GDP growth rate”. Greece’s left wing opposition has embraced this suspension of interest payments; but Hardouvelis believes it would “strain relations with Greece’s Eurozone partners” to the point of getting it kicked out of the EU.

Greece is not alone in its financial asphyxiation. The single currency exposed weaknesses in the competitiveness of southern European economies and helped channel investments to the north.

Panayotis Petrakis, an economist at Athens University, describes this unequal structure as “the new normal”. He divides the Eurozone into “a productive centre, which concentrates capital from the periphery, which will have 27-30 percent unemployment.”

But Greece is singled out by the length and stubbornness of its illness. Portugal, Spain and Ireland have begun to see a pickup in their exports, leading to a fresh flow of money to pay off debts. Greece’s pickup has been much slower – an indication of the investor-unfriendliness it has to fix at home, and this is the nub of the problem.

“Suppose for twenty years we have no problem with the debt,” says Hardouvelis. “Are we going to fix a country that generates the income that, when the time comes, enables the future rich Greeks to pay back the debt? … The question always comes back to us.”