MONDAY VIEW: Greece may have to restructure to avoid a tragedy

This week has been full of articles,  programmes and events marking the first birthday of the UK coalition Government. However, last week also marked the anniversary of agreement on the terms of the financial rescue package for Greece.

A European Union flag flies in front of the Acropolis in Athens

Tough choices: The Greek government has begun to take the bold and extremely unpopular measures it promised in return for assistance

And like the coalition, the last year has not been plain sailing. Indeed, recent weeks have seen increased speculation about a restructuring of Greece’s debts, perhaps even a default.

The markets are currently demanding a 25pc yield on two-year Greek debt compared to 16pc for ten-year debt, which shows the markets believe there is a significant risk of default in the short term.

It is obvious Greece will not be able to return to the markets for a while and will continue to rely on further European and IMF funding to carry on operating.

Why is Greece still in this predicament? Did the rescue fail? Yes and no.

The Greek government has begun to take the bold and extremely unpopular measures it promised in return for assistance.

Pay, jobs and pensions in the public sector have all been cut. Hardly a week goes by in Athens without at least one major strike.

Nevertheless, if Greece is to meet its target of generating a primary budget  surplus by 2014, it has to do more – much more than even George Osborne set out to do.

In addition to cuts, the Greek finance minister has announced ambitious goals to improve public finances through 35billion euros of asset sales (which may include airports, ports and real estate) as well as over 11billion euros from more effective tax collection.

 


The markets have been more sceptical about the ability of the Greek government to deliver these targets: they require an efficiency not seen to date.

Greece’s problems have not been helped by revisions to their financial data which reveal the task facing them is greater than anticipated a year ago.

The estimated budget deficit for 2010 was recently revised up to 10.6pc of GDP.  That is a huge gap to close in four years.

The fundamental question, however, is whether Greece will ever be able to repay its debts. Even in the good times, Greece was finding it difficult to remain competitive in the eurozone and the austerity measures implemented to put the public finances in order are reducing economic activity.

Although surprisingly output seems to have expanded somewhat in the first quarter, the IMF is forecasting GDP will fall by 3pc this year and growth thereafter will be slow to resume.

If Greece was outside the euro area, it would simply have allowed its currency to depreciate and thus reduce the value of the outstanding debt. That is not an option with the euro.

So the best outcome for Greece probably would be if it negotiated an orderly deferral and reduction in its debt obligations – a package that maintained the pressure and incentives for long-overdue economic reforms but allowed it a little more breathing space to grow.

The barriers to this are political as well as economic. Politicians in the creditor nations within  the eurozone, especially  Germany, will be concerned about the effects of a default on the financial health of banks in Germany and France that lent to Greece.

But they will be equally conscious that their voters do not like subsidising the ‘profligate’ Greeks – or the Irish, or the Portuguese.

Hence, while a restructuring is almost inevitable, it might not come yet because the political will is not there – and when it comes it may indeed be messy.

This can only be avoided if  a solution is found for all ‘periphery countries’ simultaneously, i.e. also including Ireland and now Portugal.

This would avoid the ‘moral hazard‘ concerns of  the northern European countries should Greece be allowed to restructure ahead of the others.

In the meantime Greece will remain within the euro given the horrendous financial and economic problems an exit would bring about.

But there will be further crises along the way unless ways are found to bring about long term sustainable growth for these countries, which is the only way they will get out of their current predicament.

Vicky Pryce is a senior managing director at FTI Consulting. She was born and brought up in Greece

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