from Macro and Markets

Déjà vu in Greece

June 24, 2015

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Here we go again. The counterproposal from Greece’s creditors has been leaked, and it underscores how far apart the two sides remain on a range of issues: VAT, corporate taxes, and especially pensions. Greek Prime Minister Alexis Tsipras has been called to Brussels to join European finance ministers in a marathon push today to negotiate a compromise that will release critically needed funding. We heard reports today of Greek backtracking, of the IMF’s deep resistance to the Greek proposals, and the prime minister’s questioning of his creditors’ motives. This is a dynamic we have become all too familiar with. It doesn’t preclude a deal, but it makes it harder to get to “yes” and contributes to short-term, kick-the-can solutions.

If a deal can be agreed tonight, it would be confirmed by leaders tomorrow, then debated in the Greek parliament during an emergency, three-day weekend session and be voted on Monday. There is substantial “deal risk” that parliament could reject the deal and the government fall or be forced to call a referendum. Even in the best scenario, bailout funds would not be disbursed until (still-to-be-agreed) prior actions are met, suggesting that the IMF (and other) payments would be delayed.

There is a tragic irony to this fiscal déjà vu, both in the inability of the negotiations to make progress except at the edge of the cliff, and more substantively in the overreliance on fiscal adjustment. The Greek proposal offers €8 billion in new taxes to close the fiscal gap but avoids for the most part the structural reforms to the state that could offer hope for a return to long-term growth. Aside from a gradual increase in the retirement age and adjustment to the early retirement program, the vast majority—around 90 percent—of the €8 billion in adjustment for 2015–16 offered by the Greek government comes from higher taxes and fees. This has been the story since 2010: an excessive reliance on fiscal tightening through taxes and cuts to discretionary spending, and an unwillingness to attack vested interests in the Greek system. Until now, this happened because the Greek government agreed to a comprehensive program, then only delivered on the fiscal; here it seems to be a willingness to raise taxes in return for avoiding hard choices elsewhere. The result is a massive fiscal adjustment, a deep recession, and destabilized politics. A bridge to nowhere. While European leaders initially welcomed the offer because it broke the impasse and raised hopes of a deal later this week, the growing recognition that it is at best a stopgap measure—essentially a bridge to renewed negotiations over debt relief and reform in the fall--has contributed to the tough counterproposal this afternoon, one it is very difficult to see Syriza accepting. Further, the credibility of the Greek proposal rests on its commitment to enhanced tax collection and enforcement, on which the record of this and past Greek governments is not good.

In the meantime, in the absence of a deal it is expected that the European Central Bank (ECB) would limit access to emergency financing, which has been increased by €9 billion over the past week to €89 billion. Since European creditors are unlikely to see most of their exposure to Greece returned whether Greece stays inside or outside the eurozone, this is a direct fiscal transfer that is neither economically or politically sustainable and a decision here would be decisive. That is why, unsurprisingly, German Finance Minister Wolfgang Schäuble and his Irish counterpart, Michael Noonan, are among those reportedly pressing for curbs on emergency liquidity for Greek banks unless capital controls are imposed.

Over the longer term, we know what the best hope for sustainable growth within the eurozone looks like: The IMF has come up with a comprehensive plan including substantial debt relief that it believes can reestablish sustainable finances and growth. I do believe it could work, but am deeply skeptical that this Greek government can and would commit to and implement this program. As a result, I’m increasingly convinced that exit (after a period of bank controls and default) and devaluation is more likely to restore growth. It isn’t an easy option, and one should take no comfort from hypothetical calculations of large primary surpluses at full employment. If they exited, the depreciation would need to be substantial, the dislocations large, and the resultant economy not the one we have today. But it would be competitive.

 

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