By Satyajit Das *
Greece faces a bleak future regardless of the outcome of the current negotiations.
In an interview in June 2012 with the Australian Broadcasting Service, a bit less than two years before he became Greek finance minister, Yannis Varoufakis stated that “the Greek economy is finished.” The prediction may well be realized.
The protracted and often chaotic attempts to resolve the Greek debt issue, has created uncertainty and paralysis that has worsened Greece’s position. Banking controls combined with economic, political and social instability is continuing to inflict damage on the country. Suppliers, especially foreigners, now demand payment in advance. Businesses are closing. Jobs are being lost. Travel advisories by many countries warning of potential problems may affect tourism.
Following their government’s lead, individual Greeks are withholding debt repayments, either because they cannot make them or they believe they can negotiate a debt reduction. By one estimate, perhaps as much as 70% of Greek mortgages are in default.
Economic activity has slowed, with the economy probably having slipped into recession — reversing the modest growth in 2014. The primary budget surplus has fallen, perhaps slipping into deficit. The banking system is fragile, vulnerable to any reduction in ECB liquidity support. In essence, the economy has deteriorated and the outlook is now poor.
The Syriza government’s reform agenda was intended to tackle deep-seated problems. These include: addressing public finances especially tax collection; reforming a large and corrupt government sector; reforming public pensions; reducing the power of business oligarchies, and reversing rampant clientele-ism and reducing regulations to open up closed professions. Irrespective of whether Greece does or does not default or stay in the eurozone, these structural reforms are essential to Greece’s long term recovery.
Despite agreements with creditors on initiatives to address these problems, successive Greek governments have made limited progress in implementation. The Syriza government has chosen to reverse useful reforms. Like its predecessors, Syriza appears incapable of tackling fatal Greek pathologies, captive to vested interests and patronage systems in Hellenic society.
The debate has become one dimensional, focusing on the size of the budget deficit and debt. Without structural changes, Greece faces a bleak future regardless of the outcome of the current negotiations. The future now is privation within or outside the euro EURUSD, -0.0178%.
Even a debt write-down and large devaluation after abandoning the euro and reintroducing new drachmas might not improve long term competitiveness because of Greece’s dysfunctional political and economic system.
For Greece’s creditors, any victory may also prove Pyrrhic in nature.
The primary objectives of the 2009 European bailouts were to ensure survival of the eurozone and avoid European banks having to take large losses on their Greek exposures. Assistance to the peripheral economies was always incidental to these primary motives. Far from succeeding, the strategies have made the problem bigger. This is the result of confusing solvency and liquidity problems.
The eurozone cure — bridge funding, lower interest rates (via subsidized rates and the ECB’s actions), reforming public finances — assumed a short-term liquidity problem, which could be quickly corrected allowing borrowers to regain access to commercial funding. In reality, Greece was insolvent with no hope of ever paying back its borrowings.
The curative measures had several predictable, if unhelpful, effects. Austerity to reduce debt and restore public finances resulted in an economic death spiral of reduced public spending, higher taxes, lower growth, lower investment and consumption and higher unemployment. The process undermined any debt repayment capacity.
Rather than writing off the debt and seeking to restructure the borrower to regain competiveness and growth, more funds were advanced to Greece, increasing the country’s already unsustainable debt load. Private lenders, especially European banks, were allowed to transfer their exposure to governments or official agencies and bailout funds, backed by governments. The IMF minutes for May 2010 noted that the bailout loans were not “a rescue of Greece” but “a bailout of Greece’s private debt holders.” Ironically, the most recent bailout perpetuates these mistakes.
The effect of these ill-considered actions has left eurozone members with sizeable and growing direct and indirect exposures to Greece. Delay increases this exposure. With its total exposure of around 330 billion euro and rising, the eurozone finds itself facing a choice of continuing to lend more to an insolvent borrower or cutting off funding precipitating large losses. If Greece defaults, then member nations, many of whom face significant economic and borrowing problems of their own, would incur losses of around 2%-4% of GDP. The only current strategy is to roll over loans indefinitely at extremely low interest rates. Creditors can pretend that there is no loss, although economically it is equivalent to writing off debt.
Direct financial losses are likely to be compounded by the effects of currency and interest rate volatility and destabilizing speculation about the future of the eurozone. The ability of individual nations to meet deficit and debt targets is compromised. The effectiveness of existing ECB programs will be affected.
European leaders and functionaries refuse to admit the problems of the strategy, preferring to continue with it. They also refuse to acknowledge the incompatibility of the single currency with fundamentally different economies. They refuse to deal with the conflict between the euro and limited coordination of fiscal and other policies of individual nations. European leaders do not recognize the lack of progress towards and perhaps impossibility of the premise of the 1957 Treaty of Rome, which founded what is now the EU: “An ever-closer union among the peoples of Europe.”
*Satyajit Das is a former banker. His latest book is “A Banquet of Consequences” (source MW MarketWatch)