Challenges ahead for Greek bailout implementation

The first payment under the third Greek bailout is due on Thursday, in time to allow Greece to make a key €3.5 billion repayment to the ECB. Greek default and the threat of a euro exit has thus been avoided, but the challenges attached to implementing the programme are immense, with Greece likely to head for a general election and a significant gap likely to emerge between the EU countries and the IMF on the way forward. Even if Europe offers relief on Greece’s debts, the tax hikes and spending cuts agreed will slow the economy. The question is how Greece can attain the momentum needed to exit the bailout programme after its three-year term, if the whole thing holds together that long.

To work, bailout programmes need two key components. One is an element of “shock and awe” when they are announced – a feeling that so much money is being made available that a lot of the possible risks are removed. The second, related, issue is the ability to shift the economy back into positive mode before the money runs out and to persuade private sector financiers to start lending again.

In Ireland’s case, in the dark days of late 2010, the €85 billion bailout appeared sufficient to meet our needs, although there were fears about the financial sector. Even then, it still took until early 2012 before any sign of momentum started to move in our direction, after a couple of years of a flat economic performance.

Additional hurdles

It was not easy for Ireland, and Greece faces some additional hurdles: n It is now entering its third programme, the economy has already contracted by 25 per cent and is expected to shrink this year and next . Further tax increases and spending cuts will take a toll. Greece may have failed to implement many of the economic reforms it promised, but it did “do” austerity. Now it faces more and it is hard to see where growth will come from over the term of the programme, despite the official forecasts that the economy will gradually turn upwards. Irish growth was supported by the export sector first, but Greece is more reliant on the domestic economy. If the growth targets are not achieved, then the debt and deficit targets become all the more difficult.

n It is not clear that the programme can get going in the way intended in the months ahead. The IMF says it will not sign up to provide a chunk of the cash until Europe offers enough debt relief to make the sums look more sustainable. Germany wants the IMF involved, feeling it brings a discipline and expertise. The money will only be disbursed if Greece continues to meet its reform commitments, which will be politically difficult, with a general election likely in the months ahead. With these competing agendas at play, the key test of initial credibility for the programme is in doubt. n The Greek banks are in a hole. So were the Irish ones, of course, but Greece’s banks have not been fully operational for a prolonged period. An initial planned recapitalisation of €10 billion will only paper over the cracks. The sector will have to be reformed, restructured and recapitalised after regulatory tests in the Autumn and it also needs fresh ECB liquidity. Bondholders, including senior bondholders, will face loses, although the amount of bond debt in the Greek banks is limited. Restoring a working financial system will be a huge job.

Debt

ratio

Underlying all this is the key question of debt sustainability. The traditional measure used here is the ratio of debt to GDP– which compares the size of the debt to the size of the economy. Ireland’s ratio peaked at around 120 per cent. Greece will hit 200 per cent as things stand.

This overstates the problem – a bit anyway. Greece’s main creditors are now the EU and IMF who have already extended its existing debt maturities. They are now giving it another €86 billion on favourable terms – with an interest rate of 1 per cent, an average term of more than 32 years and a holiday on principal repayment. Even so, re-entering normal commercial borrowing markets after three years looks a long shot.

Chance for growth

Belgian economist Paul De Grauwe, an acknowledged European expert who lectures at the LSE, argues that this means that the much-quoted debt ratio “vastly overstates the effective debt burden”. He points out that debt servicing as a percentage of GDP is already a bit lower in Greece than in countries such as Ireland. His argument is that Greece could move to a sustainable position if European countries accept that earlier debt will never be fully repaid and an easing of austerity gives a chance for growth, even at a relatively low level.

Europe is to discuss whether debt relief is needed during the Autumn – and some move to lengthen maturities yet further is possible – but no write down of debt will happen. Meanwhile the austerity programme remains in place. The key question is whether, against this backdrop, growth in Greece can rebound, as it did in Ireland. It will be a long road.