Cycle of loans to pay loans is clearly unsustainable for Greece’s economy
AS the clock ticked midnight on Tuesday Greece missed its deadline to repay around € 1.6 billion (R22bn) to the International Monetary Fund (IMF). Technically this is not yet a default as the IMF has put Greece in arrears and it still has an opportunity to pay the money back. Only Somalia, Sudan and Zimbabwe have ever failed to pay back their loans to the IMF.
Through the European Commission (EC), the other euro nations have offered to step in and lend Greece enough money to pay back the IMF while it renegotiates its debt load. This pattern of covering old debt with new debt – more commonly referred to as a “bailout” – is nothing new however.
Greece’s troubles started as early as the mid-1990s when it was spending more than its tax revenues would allow. Its debt to cover this shortfall gradually rose. In 2009 – amid global financial crisis – Greece announced that its budget deficit had reached 13.6 percent of gross domestic product.
High risk
Investors took note and Greece became a high risk destination for financial investments – such as the purchase of bonds. Interest rates on Greek bonds rose to compensate for the risk and Greece was forced to pay higher interest payments on its new debts – further increasing the pressure on the budget deficit.
In 2010 it became apparent that Greece would not be able to pay back its existing debt which it owed mostly to French and German banks. If Greece defaulted on these loans it would have a severe impact on the French and German economies, and the European banking system. Interest rates across the region would increase and the euro would depreciate.
Greece was therefore lent new money by the IMF and a group of European governments so that it could pay back its old debts and keep the European financial system in good shape. These new loans however, came in part from the countries that it owed money to in the first place and attached to them were much stricter conditions on how Greece should run its economy. Commonly referred to as “austerity measures”, these conditions promoted a significant drop in government spending and an increase in taxes.
While this sounds like a logical solution in terms of accounts management, a drop in government spending means less investment into the local economy, lower pension and grant payments, and less government employment. Increased taxes mean less disposable income for consumers and lower sales for businesses. Greece’s economy slowed and unemployment shot up.
In March 2012 – when it was clear that Greece would not be able to pay back the 2010 loans – it was bailed out once again with the same conditions attached. In early 2015, tired of playing second fiddle to the EU, the Greek public kicked out their government and voted for a left-leaning coalition government that claimed it would be more resilient to outside pressure and regain control over domestic economic policy.
Turmoil
The turmoil in the last few weeks has not been about whether Greece would pay back their loan – they can’t – but rather about whether they will accept the conditions attached to yet another bailout. In the time that I have been writing this, Greek Prime Minister Alexis Tsipras has announced that Greece is willing to accept the demands of the EC, but with a few amendments to the conditions.
Beyond the smoke and mirrors of convoluted economic debate the fundamentals remain clear – the Greek economy is not generating wealth and the cycle of using loans to pay loans is unsustainable.