Time for debt re­duc­tion in Greece

Financial Mirror (Cyprus) - - FRONT PAGE -

Once again, Greece is at an in­flec­tion point. With its cash bal­ances se­verely stressed, it seems un­likely to be able to pay the cas­cad­ing debt pay­ments that are fall­ing due over the next few months. So, yet an­other round of con­tentious and pro­tracted dis­cus­sions with its cred­i­tors is un­der­way – one that may well pro­duce yet an­other short­term so­lu­tion. Yet, kick­ing the can down the road is hardly the ne­go­tia­tors’ only op­tion. In­deed, it is the wrong ap­proach.

When fac­ing se­vere pay­ment prob­lems, a coun­try has five basic ma­neu­vers at its dis­posal. It can, first, draw down the mon­e­tary re­serves and wealth it has built up dur­ing bet­ter times and, sec­ond, bor­row ex­ter­nally to meet pay­ments fall­ing due in the short term. Third, it can si­mul­ta­ne­ously or sub­se­quently im­ple­ment do­mes­tic aus­ter­ity mea­sures (such as higher taxes or spend­ing cuts) that free up re­sources to make debt pay­ments.

Fourth, a cash-strapped coun­try can also im­ple­ment strate­gies to spur eco­nomic growth, thereby gen­er­at­ing in­cre­men­tal in­come that can then be used for part of the pay­ments. And, if none of this works, it can pur­sue a fifth op­tion: al­low mar­ket forces to im­ple­ment the bulk of the adjustment, whether through very large move­ments in prices (in­clud­ing the exchange rate) or by forc­ing a de­fault.

Most econ­o­mists agree on the ideal mix and se­quenc­ing of such ma­neu­vers. A so­called “beau­ti­ful de-lever­ag­ing” entails a com­bi­na­tion of in­ter­nal re­forms, fi­nanc­ing, and ju­di­cious use of the mar­ket pric­ing mech­a­nism.

But what looks good in the­ory has proved dif­fi­cult to im­ple­ment in prac­tice. For one thing, politi­cians are more likely to con­tinue in­creas­ing their coun­tries’ re­liance on fi­nanc­ing, thereby height­en­ing the risk of dis­or­derly mar­ket ad­just­ments, than they are to im­ple­ment dif­fi­cult struc­tural re­forms and fis­cal ad­just­ments. For this rea­son, many coun­tries have en­dured painful dis­rup­tions that have ag­gra­vated pos­si­bly avoid­able falls in out­put, caused un­em­ploy­ment to surge, and, in the worst cases, eroded po­ten­tial growth. In any case, if a coun­try is al­ready too deeply in­debted, it may find that no amount of re­al­is­tic adjustment and fi­nanc­ing is enough – the curse of what econ­o­mists call the “debt over­hang.” Un­der these cir­cum­stances, re­liance on aus­ter­ity to free up in­ter­nal re­sources to ser­vice the debt chokes off eco­nomic growth. And progrowth sup­ply-side re­forms can­not yield re­sults fast enough to off­set this im­pact.

Ex­ter­nal cred­i­tors, for their part, balk at the prospect of pro­vid­ing the fi­nanc­ing the coun­try needs to get back on track, with those that pro­vided fi­nanc­ing ear­lier of­ten un­will­ing to ac­cept losses. This leaves only one real op­tion: a dis­or­derly mar­ket adjustment.

Be­cause such an adjustment is not much more ap­peal­ing for cred­i­tors than it is for debtors, both par­ties en­gage in time­con­sum­ing rounds of “ex­tend and pre­tend” ne­go­ti­a­tions, in the hope that some mag­i­cal so­lu­tion will emerge. Of course it doesn’t. On the con­trary, dur­ing the time they waste, the debt grows heav­ier, not only weak­en­ing the debtor’s short-term prospects, but also dis­cour­ag­ing in­flows of new cap­i­tal and in­vest­ments that are crit­i­cal to fu­ture growth. That, in a nut­shell, is the story of Greece. By avoid­ing de­ci­sive action to ad­dress the debt over­hang, the coun­try and its cred­i­tors have con­trib­uted to a sit­u­a­tion that is dis­ap­point­ing for ev­ery­one. Greece’s Euro­pean part­ners have noth­ing sub­stan­tive to show for the bil­lions of eu­ros they have lent the coun­try. The In­ter­na­tional Mon­e­tary Fund and the Euro­pean Cen­tral Bank, which have gone along with the ex­tend-and­pre­tend ap­proach, have placed their cred­i­bil­ity at risk.

But the big­gest losers have been Greek cit­i­zens, who suf­fered through one of his­tory’s most se­vere aus­ter­ity pro­grams but still can­not see light at the end of the tun­nel. In­deed, Greece’s debt-to-GDP ra­tio to­day is con­sid­er­ably higher than it was when its aus­ter­ity ef­forts be­gan. And youth and longterm un­em­ploy­ment have re­mained at ex­tremely high lev­els for an alarm­ingly long time.

Greece’s dis­mal growth per­for­mance over the last eight years con­trasts sharply with the per­for­mance of the other eu­ro­zone mem­bers that faced crip­pling pay­ment pres­sures. Not hav­ing fallen as hard as Greece, Ire­land and Por­tu­gal have bounced back to pos­i­tive growth. Even Cyprus has per­formed bet­ter, avoid­ing eco­nomic col­lapse and re­cap­tur­ing growth in the last two years, whereas Greece re­lapsed into re­ces­sion.

The Greek econ­omy’s per­for­mance also looks weak rel­a­tive to that of Ice­land, a coun­try that, lack­ing the ex­ter­nal sup­port that Greece re­ceived, en­dured a vi­cious mar­ket adjustment. While it faced a broadly sim­i­lar eco­nomic con­trac­tion for a cou­ple of years, growth has re­cov­ered ro­bustly, and now far out­paces that of Greece.

As Greece and its cred­i­tors (now mainly sov­er­eign lenders and mul­ti­lat­eral in­sti­tu­tions) de­lib­er­ate about how to ad­dress the coun­try’s loom­ing cash crunch, they should recog­nise these dif­fer­ences and learn from the mis­takes of their past ap­proach. The longer they deny re­al­ity, the greater the dam­age will be – and the more it will cost to re­pair it.

Kick­ing the can down road is po­lit­i­cally eas­ier than reach­ing com­pre­hen­sive and last­ing so­lu­tions. But it sel­dom works. Greece can over­come its eco­nomic trou­bles only if it mod­i­fies its ap­proach. Specif­i­cally, Greece and its cred­i­tors must agree to a cred­i­ble deb­tre­duc­tion pro­gram that would sup­port the do­mes­tic re­forms needed to re-in­vig­o­rate Greece’s growth engines and place its in­ter­nal obli­ga­tions in line with its ca­pa­bil­i­ties. Such an ap­proach, which is al­ready favoured by the IMF, would boost Greece’s fu­ture growth prospects con­sid­er­ably.

If clear eco­nomic logic some­how does not pro­vide suf­fi­cient mo­ti­va­tion for Greece’s Euro­pean part­ners to sup­port debt re­duc­tion, surely Greece’s front­line role in Europe’s his­toric refugee cri­sis does. Af­ter eight long years, it is time to give Greece the help it needs, in the form of a proper growthori­ented round of debt re­duc­tion.

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