Greece’s outlook after the new troika deal
Government in Athens gets more time to implement fiscal reforms, return to a primary balance and chart a course toward recovery
TAhe fifth financial tranche of loans from the country’s international creditors will be paid out. An agreement with visiting officials from the European Commission, European Central Bank and International Monetary Fund – collectively know as the troika – has been announced and then relayed by Prime Minister George Papandreou to Eurogroup chief Jean-Claude Juncker in Luxembourg.
The interesting detail is that Papandreou has done it, not his finance minister, as in the past. Possibly the PM is taking a more assertive role; something that many have been waiting for. But even if payment of the tranche has been secured, each subsequent quarterly evaluation is becoming ever more difficult and subject to higher levels of risk (i.e. nonpayment) and conditionality (e.g. redundancies in the public sector).
The danger moving into the second half of 2011 and early 2012 is that at some stage one of the troika’s members is going to pull the plug. If I had to put my money where my mouth is, I would think that it is the IMF that is coming ever closer to withdrawing from the financing arrangement.
The Washington-based fund has repeatedly warned that it could withhold the 3-billion-euro share of the fifth 12-billion-euro troika tranche to be paid out next month. The IMF is seeking assurances that Greece is fully funded in the next 12 months and would thus not default.
As has been the case so many times before during the past 16 months, one of the rating agencies has again downgraded Greece during an evaluation by the troika. In this case it was Moody’s, which downgraded Greek sovereign debt to Caa1, on a par with Cuba, and raised the country’s risk of default. For a sovereign rating to fall within less than two years from A to this (junk) status is entirely new territory, and not only in the eurozone.
However, in my view, the timing of the downgrade without awaiting the outcome of the evaluation is a political scandal. In a way, the three leading rating agencies’ untimely but deliberate interventions suggest that they have through the back door become part of the policymaking process in Athens and beyond. Such repeated rating action and unprecedented influence must be addressed in current discussions about regulatory reform on rating agencies in Europe, as is being considered by the Commission and the EU Parliament.
After all, how stable is a currency union in which member states and millions of citizens literally depend on the assessments of three private institutions who hold a monopoly over ratings and governments to ransom?
The negotiations with the troika during the past weeks in Greece have illustrated that a radical tax reduction program, as proposed by Antonis Samaras, the leader of the main opposition New Democracy party, has no support among the government, the IMF, the EU and the ECB.
Samaras’s proposition for the introduction of a “flat tax” of 15 percent overlooks Greece’s key structural problem, namely the improvement of collection capacity (enforcement) and the enlargement of the tax base.
Government revenues fell in the first five months of 2011, creating a 2.6-billion-euro fiscal hole. Specifically, revenues for the January-May period fell to 17.9 billion euros, from 19.7 billion in the same period last year. The Finance Ministry had expected to collect 20.5 billion euros for the five-month period.
The Papandreou government has adopted a yearly, staged corporate tax reduction roadmap, in which a 1 percent reduction will be introduced, starting this year. Corporate tax currently stands at 23 percent and is to go down to 20 percent by 2014. If any further tax reductions are to be introduced this year and next, then I expect this to be the case in the field of reducing value-added tax (currently 23 percent) and merging existing VAT categories from three to two, 20 percent and 10 percent respectively.
The thematic focus of the troika agenda is gradually being enlarged. Today, the government and the troika are discussing:
a) Stimulus packages for the economy;
b) A targeted investment component including projects in sectors such as tourism, shipping, green technology and retailing;
c) The scope and range of collective bargaining agreements and to what degree employers are bound by them;
d) Public sector employment levels (new replacement ratio 1 for 10), the merging of public organizations (schools, hospitals, insurance plus pension funds) and utilities;
e) Broadening the tax base (reduction of tax-free income threshold from 12,000 euros to 6,000 euros);
f) Privatization, the creation of an independent agency to oversee the privatization drive and how to use privatization revenue, reprofiling (different versions).
This extension of the agenda is necessary and constructive. It leads away from a far too narrow focus on spending cuts (6.4 billion euros in 2011) and austerity policies.
At the political level, Papandreou is seeking a broader cross-party consensus in Parliament, in particular with New Democracy. These efforts have not been successful at all. However, while he seeks such consensus between parties he is losing consensus inside his own governing party. Sixteen PASOK deputies have written to the prime minister asking that Parliament be given time to properly debate the new set of austerity measures Greece is about to agree with the troika.
After one year in operation, the present framework as agreed in May 2010 between the Papandreou government and the troika is proving to have been unrealistic in substance and far too optimistic regarding the timetable (e.g. when Greece would be able to return to bond markets). Hence we are now entering the re-engineering phase of the framework. What are the possible scenarios in the short term, i.e. until end-2011?
a) The option of a voluntary euro exit by Greece is rejected at the political level in Greece and in the EU. However, gradually a groundswell of skepticism and even outright rejection is gaining force within parts of Greek society. The protesters from the “Won’t Pay” movement, who refuse to pay road tolls as well as the “Indignant” movement currently occupying Syntagma Square articulate an undercurrent of drachma nostalgia and anti-EU/anti-euro sentiment. The composer and national icon Mikis Theodorakis publically called for Greece to exit both the eurozone and the EU during a May 31 protest rally in front of Athens University, receiving long and loud applause for it. Finally, the Greek EU commissioner for fisheries, Maria Damanaki, is said to have warned that either the crisis be soon resolved or Greece should exit the euro.
b) The option of Greece declaring bankruptcy or being forced into insolvency, while considered realistic by many and even essential by some commentators, is politically a nonstarter for the Papandreou government, the ECB, the EU and – so far – the IMF (see Lorenzo Bini Smaghi interview in the Financial Times on May 30, 2011).
c) If the European members of the troika agreed to foot the IMF share in case the latter, temporarily, withdrew or withheld further financial assistance, a new assistance program for Greece would not be necessary. However the question is where would the financial resources come from?
(i) The EU facility (EFSM) is already stretched with the Greek, Irish and Portuguese obligations.
(ii) Alternatively, the EFSF could be involved in the Greek financing architecture (requires mandate extension). The advantage of this option is that it does not require approval from national parliaments. The disadvantage is that the noninclusion of the IMF would be particularly alarming for Germany, which has always insisted on the Washington-based lender being involved.
d) A new loan guarantee program is agreed by eurozone finance ministers and the IMF to the tune of roughly 60 billion to 70 billion euros for Greece. The details to be addressed are manifold:
(i) What would be defined as voluntary burden sharing with private bondholders? Any consensus on cooperative debt approaches, e.i. bond rollovers as a pillar of a new aid package, has to be structured in such a way that it does not trigger a so-called credit event. Investors may be given incentives such as preferred creditor status, higher coupon payments, collateral or preferential treatment in the future if another rescheduling is needed.
(ii) A German plan calls for investors who hold Greek bonds maturing between 2012 and 2014 to voluntarily exchange those for new sovereign debt instruments with an extended maturity of seven years. Creditors would have to be motivated to join in such a voluntary exchange with the help of a so-called “collective action clause.” These would need to be introduced into existing bond contracts in the event not enough private investors were prepared to take part.
(iii) However, to structure a conversion of sovereign debt while avoiding the classification of a credit event by rating agencies is akin to squaring the circle. Moreover, debt rollovers may do little to reduce Greece’s rising public debt load.
(iv) What is the range of additional conditionality that Athens would have to adhere to? Further tax increases, significant downsizing of public sector employment, restructuring, merger or closure of public entities and the rationalization in entitlements are all on the agenda. What was only recently considered a red line is fast becoming the order of the day, mandated by the troika and subscribed to by the Papandreou government in June 2011.
(v) (i) What is the roadmap and realistic timetable for the adoption of such a “Greece 2.0” program? (ii) How will Chancellor Angela Merkel in Germany or caretaker governments in Belgium, Finland and Portugal be able to receive parliamentary approval for the new financing facility for Greece?
Ultimately, a new aid package may be more about buying time for Greece and Europe’s financial sector to prepare for any worst-case scenario. The strategy of playing for time will help Europe’s banks provision against future losses on sovereign debt, first and foremost from a potential restructuring of Greek debt, but possible also including Ireland and/or Portugal. Finally and perhaps most critically, time also enables the three program countries, Greece, Ireland and Portugal, to implement fiscal reforms, return to a primary balances and chart a course toward economic recovery.
Greece is facing the end of an era. Everybody knows it. There is nothing left in the state budget to distribute. There is no more cheap money available on international bond markets to borrow. And there is no social contract anymore between citizens/society and the state/political elites.
Against this background, one group will fight tooth and nail to protect their entrenched interests. And the other group will continue meeting at Syntagma Square – under the Spanish-inspired umbrella term “Indignant” – and shout “Thieves” as well as ’“Go away” at those sitting in Parliament. At the end of the day, what we are facing today and in the coming months in Greece is the challenging and desperate attempt to formulate a new social contract between state and society, between political elites and citizens.