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Analysis

Greece may provide salutary shock

by Vicky Pryce

Greece may provide salutary shock

These are dangerous times for Europe. Everyone is watching Greek developments. The question is whether and when policy-makers will realise that Greece is not an exception in the euro area which has to be treated in a certain way because of its problems. It is much more a symptom of what is wrong with the euro project as a whole.

The flaws are well known: no central transfers of funds, no mutualisation of debt, and no lender of last resort – until the president of the European Central Bank famously announced in 2012 that he would do whatever it takes to save the euro.

Mario Draghi has shown that he means business. Despite German opposition, the ECB will embark on a €1.1tn quantitative easing programme from next month. But there is much work to be done to remodel the rest of the euro structure to tackle the crisis that has been created. A serious rethink is needed.

Pain for Greece

The heart of the problem is that, in the absence of a fiscal union and adequate and timely support to head off crisis, national governments have been given no choice but to cut back sharply to achieve fiscal consolidation and reduce debt. The pain for Greek citizens has been enormous. In Greece GDP has fallen by 25% in five years.

Against this backdrop came the rise of Syriza, a collection of ex-communists and disaffected MPs and voters from the centre-left Pasok and other smaller parties. In the 25 January election, the party increased its vote to 36% from just over 4% 10 years ago and 27% in 2012. It narrowly failed to get a majority despite being allocated the 50 seats which automatically go to the largest party under the peculiar Greek electoral system.

Charismatic head

Alexis Tsipras, Syriza’s charismatic head and now prime minister, swiftly formed a coalition with a small populist right-wing party, the Independent Greeks, and was sworn in the next day. The Independent Greeks, whose leader has made unpleasant remarks about Jews and Muslims, may seem a strange bedfellow for a radical left-wing party, but they are united by extreme dislike of the austerity package and how it has been forced on Greece. The Independent Greeks provide another useful benefit: they stave off attacks from the far right that Greece is becoming communist.

Financial markets have been nervous, especially after the ECB announced on 4 February it was no longer accepting Greek government bonds as collateral for Greek banks’ funding. The Athens stock market has been weak and 10 year Greek bond yields have risen to above 10%. The market will remain volatile as long as negotiations are not concluded about the future of the bail-out programme.

The bail-out programme has so far extended to the end of February, but no one knows how and if it will continue. At stake are austerity conditions imposed on Greece including details of the 2015 budget and Greeks’ demands for debt restructuring – a potential stumbling block.

Effect on Podemos

The shouting match has started. Both sides ask for all and hope to get something in return. The Europeans, led by German Chancellor Angela Merkel and her Finance Minister Wolfgang Schäuble are playing tough. The Finns and the Dutch are just behind. The Spaniards, who are also creditors to the Greeks, are voicing concerns about any deal that may be struck. The Spanish government is particularly mindful of the effect on Podemos, Spain’s own antiausterity party which is riding high in the polls in advance of elections at the end of 2015. Negotiations need to be concluded quickly for three reasons. First, Greece will be running out of money to pay back some €10bn of loans falling due over the next six months.

funds and will not be able to rely on ECB support if Greece unilaterally exits the bail-out programme after the extended deadline of 28 February. Emergency liquidity assistance (ELA) from the Bank of Greece is continuing up to a ceiling of €60bn, but is subject to ECB approval.

Third, the collateral that banks offer for funding is coming under pressure, as the 4 February ECB decision showed. The banks’ holdings of bonds and Treasury bills issued by the Greek government are dropping in value, and the same is true for the potential bad loans on their books. With the Greek economy likely to fall back as businesses hesitate to invest or hire workers this will lead to an increase in nonperforming loans which already represent about one-third the four main Greek banks’ loans.

Some red lines have become clear. The main element of Greek government policy is that the country has to turn a new page beyond austerity. It is now clear that prescription advanced by the ‘troika’ (the IMF, the ECB and the European Commission) has not worked. The IMF itself has accepted that, and Mark Carney, the governor of the Bank of England, criticised the euro area in late January for over-restrictive fiscal policies and lack of fiscal union in the form of transfers from rich to poor countries. Important support is coming, too, from the US. In an interview after the Greek elections, President Barack Obama said, ‘You cannot keep on squeezing countries in the midst of depression.’ He added, ‘The best way to reduce deficits and restore fiscal soundness is you must grow’. This statement has been much replayed in Greek media.

The Greeks, above all Tsipras and Yanis Varoufakis, finance minister, have made clear that the troika is dead. They do not recognise the authority of what they believe is an undemocratic body. In this they appear to have won. Commission officials and political representatives seem to accept that a different dialogue needs to be found. This creates its own problems. Dealing separately with each member of the European Union, the Commission, the ECB and the IMF is not easy, especially with the aim of reducing Greece’s unsustainable debt burden of 175% of GDP. But it needs to be done, and quickly.

Compromise on debt

Syriza won the most votes on a promise to end austerity but also to reduce the burden of debt, with some of its pre-election pledges suggesting that they wanted to write off half of it. Germany and others have made it clear that no such deal can be done. Varoufakis, who has spent a week on a tour of European capitals, has bluntly disagreed with both Schäuble and Jeroen Dijsselbloem, the Dutch finance minsiter and Eurogroup president. There will be bluff and counter-bluff.

There is an element of stage management here. Varoufakis, a steely economist, has practised in public a threatening and somewhat confrontational tone, while Tsipras has appeared to be more conciliatory. In private, however, the two men are adopting a similar attitude, assuring bankers and other creditors that Greece will honour its obligations, particularly to the ECB and the IMF, and will eschew unilateral action. The truth is that the average Greek is not expecting miracles but would be pleased if some of the austerity burden were lifted. Compromise is in the air. Greece does not want to leave the euro; nor does Europe want this to happen, which would presumably lead to Greece leaving the EU as well, with enormous repercussions.

The Greeks will no doubt win some concessions. These may come in the form of longer maturities on debt, lower rates and possibly a further loan agreement to see them through until they are once again able to tap the financial markets. But the negotiations will be tough. In the spirit of compromise, Varoufakis has already dropped immediate write-off demands. He has suggested instead converting current loans owed to European countries into ‘growth’ bonds with payments linked to the health of the economy, and ECB borrowings into ‘perpetual’ bonds that pay interest but have no maturity. The response so far from Greece’s creditors has been muted.

Greece will fight, too, for a less exacting primary surplus requirement, or even simply a balanced budget, well below the 4.5% of GDP demanded by the troika in 2015 and 2016.

At some point, Greece will want to be accepted in the ECB’s bond-buying programme. But write-downs will be necessary if the euro area is to return to growth. QE alone will not suffice. That would mean revisiting the debt sustainability targets of Portugal, Ireland, Spain and Italy, and rethinking fiscal policy across the euro area. The Greek election result may give Europe the salutary shock it needs to show determination to make the euro work.

Greece

Vicky Pryce is a former head of the UK government economic service and author of Greekonomics.

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