The agreement reached between Greece and its creditors in the early hours of Friday on the features of their post-bail-out relationship should be welcomed by markets as an important step in the right direction. After eight years of crisis, four governments, eight finance ministers, three bail-outs, 450 policy reforms and €274bn of loans, Greece will be exiting its third and final bail-out programme in August.
Eurogroup President Mário Centeno stated that ‘there will be no follow-up programme in Greece’ and that the agreement should ‘allow Greece to return to market financing’. In principle, this enables Greek and European governments to celebrate the ‘clean exit’ that they have been so eager to achieve. In practice, it is all but clean. The credo of ‘solidarity in exchange for reforms’ linking the Greek government and its creditors will continue after August in the form of continued enhanced surveillance and debt relief conditionality.
The debt relief measures announced on Friday are significant and close to the upper limit of what the Greek government had hoped for. They included a 10-year maturity extension for €96.6bn of European Financial Stability Facility loans from the second bail-out; the disbursement of a final tranche of €15bn by the European Stability Mechanism to help build a cash buffer to cover sovereign financing needs until the country returns to the markets; the gradual return to Greece of gains accumulated by the Eurosystem on Greek government bonds, conditional on a set of reform criteria; and scrapping a step-up interest rate margin related to the debt buy-back tranche of the second Greek programme, also conditionally.
We have repeatedly stressed the importance of such measures to ease the debt burden as a key ingredient for the country’s recovery. In that respect, the latest measures are a commendable outcome given the complexities and competing incentives of the parties involved in the negotiations. Berlin was the key obstacle, reflecting German Chancellor Angela Merkel’s domestic political fragility. Pressure from her Bavarian coalition partners over asylum rules has constrained Merkel’s ability to offer Germany’s support in other areas.
The question for Greece is whether the debt relief measures go far enough. In 2012, the Eurogroup stated it would consider debt relief measures to bring down the debt-to-GDP ratio to 110% by 2022. With debt still at almost 180% of GDP, this is far from the reality reflected in the latest measures. Of course, a lot has happened since 2012, notably the brinkmanship of 2015 that almost caused Greece’s exit from the euro altogether.
The latest measures should make debt sustainable in the short to medium term. But there are concerns over longer-term sustainability. European Central Bank President Mario Draghi stated that the ECB ‘welcomes the Eurogroup’s readiness to consider further debt measures in the long term in case adverse economic developments were to materialise’, while International Monetary Fund Managing Director Christine Lagarde stated that the Fund had ‘reservations’ about long-term debt sustainability. They are right to be cautious: given its size, Greece’s public debt will probably remain in focus for a long time. But while risks are on the downside, especially as interest rates globally begin to rise and the global recovery cycle comes to an end, Friday’s agreement is an important signal that the creditors are willing to support Greece’s recovery.
Crucially, debt sustainability depends not only on the size of the debt, but also on the parameters for its repayment that will determine its gross financing needs. These are in turn partly determined by the level of GDP, and hence the sustainability of the recovery. Aside from long-term structural weaknesses such as high unemployment (especially among young people), emigration and weak demographics, the fiscal trajectory and continuation of austerity policies do not present a promising outlook. To put the agreement in context, the country will have to run primary budget surpluses of over 2% of GDP for decades to maintain debt sustainability. For Greece, a light is beginning to flicker at the end of a very long tunnel.
Vicky Pryce, a former Joint Head of the UK Government Economic Service, is a Board Member at the Centre for Economics and Business Research and a Member of the OMFIF Advisory Board. She is the author of Greekonomics: the euro crisis and why politicians don’t get it, published by Biteback Publishing. Danae Kyriakopoulou is Chief Economist and Head of Research at OMFIF.