Prof. Dr. Paul J.J. Welfens, Jean Monnet Professor for European Economic Integration; Chair for Macroeconomics; President of the European Institute for International Economic Relations at the University of Wuppertal, (Rainer-Gruenter-Str. 21, D-42119 Wuppertal; +49 202 4391371), Alfred Grosser Professorship 2007/08, Sciences Po, Paris, Research Fellow, IZA, Bonn,
Non-Resident Senior Fellow at AICGS/Johns Hopkins University, Washington DC
July 10, 2015(www.eiiw.eu) email@example.com 2015 = 20 years of award-winning research
After the Referendum in Greece – Greek Economic Drama
The Greek referendum of July 5, 2015, has resulted in the refusal of the latest offer of the creditor euro countries. This was to be anticipated after five years of recession. Greece has experienced a real income decline of 25% in 2010-2014, a slight increase of real income occurred in the third quarter of 2014. However, anticipation of the victory of the left-wing SYRIZA party in the then upcoming elections brought down investment dynamics. Indeed with the Tsipras-led coalition government, established after early elections in January 2015, the investment GDP ratio has further declined. From 25% in 2007 it has reduced to about 12% in 2014 which is a drastic decline. 2015 will witness further reduction of the investment-GDP ratio and of the real GDP. The unemployment rate is also very high – close to 30% in mid-2015. Problems with the banking system will put further pressure on the real economy. The Tsipras government left the negotiation table in Brussels on June 25 and it effectively walked away from some € 17 billion which the country could have obtained as a bridging loan and extension of the second adjustment programme.
The Greek government had suggested that after a referendum a quick compromise would be achieved – within 48 hours; this, however, was illusory. Any agreement will take much longer to be completed since money from the ESM rescue fund would have to be mobilized to give Greece additional loans. The ESM could give new loans to Greece, but this will be possible only if the Greek government adopts more reforms. Tsipras has so far adopted no serious reforms, instead the left-wing rhetoric of the Tsipras government has discouraged investors further and the new recession of 2015 is a politically triggered economic downswing.
Alexis Tsipras has argued that the referendum – with 61% Greek vote No to the euro partner countries’/the Institutions’ proposals – will bring EU integration back to more political cooperation and an approach which would place less emphasis on the role of rules: This, however, is wishful thinking based on an inadequate analysis and similar to the fallacious hypothesis of Mr. Varoufakis, the resigned Greek Minister of Finance, who had argued that Greece would be like Italy, Spain and Portugal. However, the reaction of financial markets with regard to these countries’ interest rates on June 25 and 26 – after the collapse of the talks between Greece and the Eurozone partners – has been very small, so that the Varoufakis hypothesis is not valid.
The creditor countries of the Eurozone negotiated with Greece on June 24 without offering any debt haircut; however, this was not convincing in a situation in which the German government had declared that cooperation with Greece would be based on the involvement of the IMF; the IMF, in turn, had already indicated in a report on Greece in late June that a haircut on Greek debt would be needed to achieve sustainable debt-GDP ratios, which is the basis to keeping the IMF on board. The IMF report, Greece. Preliminary Draft Debt Sustainability Analysis, was published on June 26, however the findings were certainly available a few days in advance for all EU member countries. If all IMF member countries knew about a week before June 26 that there is no debt sustainability, why did the offer of the euro partner countries/the Institutions not suggest at least a small conditional haircut on Greek debt? This strategic mistake fuelled – one could argue – the large No majority of the Greek referendum. The fact that the Maastricht Treaty has a ‘no bail-out’ clause does not exclude the possibility that a technical approach to a haircut could be created; certainly with a strategy to make sure that, from the creditors’ perspective, the remaining debt is ‘safer’.
- The IMF itself could offer a conditional haircut. As the IMF’s stake is about € 30 bill., one may argue that a haircut of € 15 bill. might be considered – this could be split into two halves so that some conditionality can be attached.
- The euro countries could decide to transform part of the loans to Greece into a marketable product that would have a market price below 100%. Under very strict conditions, the Greek government could obtain the right to buy back part of this debt at a market price. A formula could be, for example, that for every € 50 bill. translated into an effective debt reduction, Greece must privatize the same amount of government assets, namely in an approach that involves the EBRD, which has broad experience in privatization. A maximum of € 100 bill. could thus be privatized which then would go hand in hand with a debt reduction of almost 1/3rd of the Greek government debt.
- Greece should definitely avoid the problems associated with failing to make the repayment of € 3.6 bill. to the ECB which is due on July 20. If the Greek government, which has assets of more than € 300 billion at its disposal, would be unwilling to quickly mobilize some of these large assets for privatization in order to make sure that the payments to the ECB scheduled for July 20 and August 20 are made, this would be absolutely irresponsible. It would testify to a lack of economic professionalism and an obsession with ideological goals in a situation in which about 10 million Greek people are facing dramatic economic hardship.
The ECB is likely to extend ELA (Emergency Liquidity Assistance) credits for a short period, in order to allow Greek banks to operate at a minimal level. The European Central Bank is in a critical position, namely that it can give a green light for loans of the national central bank vis-à-vis commercial banks in the country, however, the green light for giving extra liquidity to Greek banks is based on the assumption that the banks have a liquidity problem but are still solvent. Here there is a crucial problem since the bankruptcy of Greece could translate into the bankruptcy of the major banks.
Indeed, on July 20 the ECB is expecting a repayment of loans from Greece. Should this payment not be made, a prolongation of ELA is unlikely, since non-payment to the ECB implies the bankruptcy of Greece; this, in turn, undermines banks’ equity capital – banks would thus face insolvency. More than 1/3rd of the major banks’ equity capital in Greece consists of expected tax refunds from government, but if government is bankrupt, then the value of expected tax refunds will be zero. With the equity capital of banks falling dramatically, the four main Greek banks are likely to be bankrupt within a few days. A strong economic collapse would follow in Summer 201 and output could reduce by about 10% within two years.
There is no investor confidence in the Tsipras government. Hence the investment GDP ratio, having already fallen from 25% in 2007 to 12% in 2014, is likely to decline further and this implies that Greece will face a massive recession in 2015/2016. This reinforces the need for a haircut on Greek government debt. This should have been anticipated by the leading negotiators in Brussels – which was obviously not the case.
GREXIT – Greece leaving the Eurozone – cannot be excluded as the Greek government has shown a lack of cooperation with its partners and its apparent lack of professionalism in economic policy could easily generate a “Grexidant” (involuntary leaving of the Eurozone). Greece’s return to the Drachma would be a drama.
The natural starting point of Eurozone countries/the Institutions in new negotiations with Greece should be to focus on structural reforms, institution building and the issue of debt sustainability: Here, Greece itself has not delivered the promised privatization revenues; Greek government assets were estimated to be more than € 350 bill. in a 2010 IMF Report (Dec. 2010), however, by early 2015, only about 1% had been privatized. Greece could be offered a haircut on its outstanding government debt vis-à-vis public debtors, say of about € 100 billion, strictly conditional on Greece proceeding seriously with privatization and reforms plus a redesign of the Greek constitution.
If Greece should decline to cooperate along a formula of debt relief plus privatization plus structural reforms, the Eurozone countries have no reason to seek any compromise with the Greek government. A country with more than € 300 bill. of sovereign debt which has not privatized more than € 3 bill. within five years is certainly not contributing the minimum effort to solve its own serious economic problems. Such “negative solidarity” in the EU is unacceptable – thus far privatization in Greece lags far behind all the efforts that eastern European post-socialist countries made in the transition period of the 1990s.
The ESM rescue fund could take over the current position of Greek bonds held by the ECB. The ECB’s role in monetary policy should no longer be compromised through the ECB’s holding of Greek government bonds. The political and psychological strategy of Eurozone countries vis-à-vis Greece has been inadequate in Spring 2015: The impression was created that Greece could order its partners to the negotiating table almost at will. The Eurozone countries and the EU, respectively, are, however, not only facing the challenge of contributing to helping Greece sort out its economic problems – rather there are also major challenges in the field of economic globalization, amongst others, the rise of China as an economic power: the global No. 1 since mid-2015 – with income evaluated at purchasing power figures. Moreover, there is the challenge of an expansion of information & communication technology.
A useful option could be to shift all negotiations to the Paris Club, which naturally will involve, as a standard ingredient of negotiations, the IMF; there has never been an agreement in the Paris Club without the IMF. The Paris Club has been active in the debt restructuring of many developing and some eastern European countries.
What could be recommended? Greece should get a first haircut of about € 10 billion upfront on the basis of an international privatization scheme which should involve the EBRD in London, an institution which has great expertise in privatizations in almost 30 countries so far. At the Paris Club, the US, Canada, Japan, Russia and the UK would also sit at the table, in addition to the Eurozone countries. However, if the Greek government is not offering policy reforms in the form of modernizing public administration, reinforcing competition policy and accepting broad privatization, it is highly unlikely that the required political support of creditor countries – from Germany or Ireland for example – will be achieved. Without majority decisions in parliaments in several Eurozone countries, no third loan package for Greece will be possible.
Greece needs a new constitution which gives clear financial autonomy to local and regional authorities plus universities and hospitals. If such autonomy is not guaranteed, the Eurozone countries should not sign any long-term agreement with Greece, since the government in Athens could take these institutions as “hostages”. The Greek government has forced local authorities, hospitals and universities to send liquidity to the central government, however, the main idea behind this move is to organize a maximum bankruptcy case if the Greek government does go bankrupt. Moreover, the main reason that Greece has made so little progress with economic reforms in the period 2010-15 is that the quality of government and the public administration is rather poor; there is massive inefficiency in government and this will not be changed without adopting a new constitution. The quality of institutions in Greece is also rather poor. The modest reforms achieved in some fields should be acknowledged, however the speed of reforms has been rather slow. Privatization has been almost non-existent in 2010-2015.
A haircut of € 100 billion for Greece would be a burden to the taxpayer of about 1% of GDP – here assuming that only public creditors are involved. However, an adequate deal would raise the GDP of the Eurozone by at least 0.1% per year, as Greek instability would be removed, so that after a decade, taxpayers’ costs would be close to zero. The Greek problems could be solved, however, with the strange Tsipras government this will be very difficult. It cannot be excluded that Greece will, in the end, leave the Eurozone and massive chaos would emerge in Greece thereafter. The case of Greece shows that a country which does not manage its public debt in a responsible way could experience a massive economic decline and political and social instability.
The German leadership, in terms of the management of the Greek crisis, has been rather weak in some points. There was no realistic strategy for stabilizing Greece within a few years. The IMF’s forecasts of fast economic recovery in Greece have turned out to be much too optimistic – and thus the disappointment both in Greece and in the euro partner countries was considerable in the second half the crisis period 2010-2015. The key to economic recovery in Greece is higher investment and this in turn requires political stability and a consistent economic policy as well as a stable banking system.
Finally, it is clear that a Eurozone without a political union could be rather unstable; whether or not Germany and France can generate the required political momentum for a future political union remains to be seen. The Greek crisis can be solved within a few years if adequate reforms are adopted. There is no doubt that the Euro monetary union and the EU also require reforms. The picture that the EU has presented to the partners in the world economy between 2010 and 2015 has been dismal. The new Juncker Commission might bring major improvements here provided a broad reform programme is adopted.