George Alogoskoufis is Professor of Economics at
the Athens University of Economics and Business. He was a member of the Hellenic Parliament from September 1996 till October 2009. Between 2004 and 2008 he served as Greece’s Minister
of Economy and Finance
and was a member of the Eurogroup and the Ecofin Council. His research focuses on unemployment, inflation, exchange rates, economic growth and monetary and fiscal policy. He has published five books including "The Drachma: From the Phoenix to the Euro", a monetary and economic history of Greece since the 19th century, which was awarded the Prize of the Academy of Athens.
Since the beginnings of 2010, the Greek economy emerged as the first casualty of a sovereign debt crisis that still threatens to destabilize the euro area and put the fragile recovery of the European economy from the recession of 2009 at risk.
The Greek fiscal situation became the centre of international attention after the elections of October 2009. The fiscal deficit of Greece worsened during the crisis, not unlike in many other economies in the euro area and the rest of the world. In addition, after many years of strong economic growth, in 2009 the Greek economy entered into a prolonged recession, the end of which is not yet visible.
The international financial crisis hit the Greek economy at its Achilles heel: The refinancing of the country’s high public debt. Greece’s public debt was accumulated mainly during the 1980s. Although the fundamentals of the Greek economy had improved significantly in the twenty years to 2008, during preparations for entry into the euro area, but especially since Greece’s entry, public finances and international competitiveness remained as persistent and significant problems throughout the period. There were two periods of significant improvement in the fiscal situation, but there were also many instances of relapse, especially around election years.
After a steep rise throughout the 1980s, public debt had stabilized at about 100% of GDP since the early 1990s. Greece had no problem refinancing its debt until the end of 2009. However, in the circumstances of the international financial crisis, the refinancing of the debt started becoming a problem, and spreads over the German benchmark rates started to widen. The problem became much more serious after the elections of October 2009, when Greece found itself in the centre of a wave of criticism by the international press, international organizations, rating agencies and the European Commission. Despite the fact that the fiscal situation in 2009 worsened throughout the world, in many countries much more than in Greece, Greece found itself in the centre of a confidence crisis.
This happened for three reasons. First, and foremost, because of the high level of Greece’s public debt. Greece’s public debt had stabilized since the early 1990s at roughly 100% of GDP, versus 70% for the average of the Euro area. The second was the sudden announcement of the dramatic deterioration of the projected deficit and debt for 2009, by the new government elected in October 2009. This took the markets by surprise and contributed to the confidence crisis, as the previous administration insisted throughout 2009 that it would achieve a much lower deficit. The third reason is related to the delay of the new administration to start tackling the fiscal slippages of 2009, and the shortcomings of the fiscal program initially adopted, which appeared to be leading to a further widening rather than a contraction of the fiscal deficit.
Under these circumstances, Greece faced a severe confidence crisis, a sustained speculative attack on its bonds, and the eventual setting up of a special European Support Mechanism, with the participation of the IMF. Since the end of April 2010 Greece has effectively been excluded from international financial markets.
Greece found itself in the middle of a dual confidence crisis. It lost the confidence of international investors, and was thus unable to borrow internationally, and it lost the confidence of domestic consumers and investors, and thus entered into an unprecedented deep and long recession which makes its fiscal predicament even worse. At the end of April 2010 the Euro Area countries agreed to provide to Greece €80bn in bilateral loans, coordinated by the European Commission, with an additional amount of up to €30bn available from the IMF. A rolling quarterly review process of Greek efforts to address the fiscal situation before the installments are paid out was set up. Euro area countries contribute to the loan package according to the ratio of their contributions to the European Central Bank. Interest rates were set at about 5 per cent, higher than the cost of raising the funds in the markets.
At the same time, it was decided to create the European Financial Stability Facility (EFSF), that would be able to issue bonds or other debt instruments on the market, to raise the funds needed to provide loans to countries in financial difficulties. Issues would be backed by guarantees given by the euro area member countries, and would amount up to € 440 billion.
Under the conditions of the European bailout, the Greek government agreed to follow a drastic 5 year program of fiscal adjustment and structural reforms. The initial measures aimed to reduce the budget deficit by five percentage points of gross domestic product in 2010 and another four points in 2011. Greece was required to reduce its fiscal deficits below 3 per cent of GDP by 2014. The Greek program has two main aims: first, to restore the sustainability of the Greek fiscal situation and, second, to improve the competitiveness of the Greek economy.
The original adjustment program has been officially revised twice already, in the face of insufficient fiscal adjustment and another revision of Greece’s fiscal accounts. The first revision followed the decision in the autumn of 2010 to include public enterprises in the general government accounts, while the second revision, in the spring of 2011, became necessary because of the failure of the 2010 budget to meet the program targets. A third revision was under way, but the calling of new elections in May and then June 2012 has led to its postponement. However, the revised programs have a similar structure to the original program and rely on similar policies. They rely on drastic but gradual fiscal
adjustment and reforms to improve the competitiveness of the Greek economy.
In addition, as it appeared unlikely that Greece would be able to return to the markets in 2012, in July 2011, Euro Area countries agreed “to support a new program for Greece and, together with the IMF and the voluntary contribution of the private sector, to fully cover the financing gap. The total additional official financing will amount to an estimated 109 billion euro.” The maturity of official loans to Greece was extended and interest rates were reduced. The European Financial Stability Facility (EFSF) was also given new powers to make short- term loans, provide funds to recapitalize banks and in “exceptional” circumstances even buy back bonds of debt-laden governments.
There are many who doubt that Greece can indeed get out of its fiscal predicament through the stabilization program agreed between Greece, the European Commission, the ECB and the IMF.
Financial market analysts, prominent economists and influential financial newspapers have almost continuously been expressing serious doubts, arguing that Greece’s fiscal situation is unsustainable without further debt write-offs and exit from the euro area.
The fiscal adjustment effort is taking place in a framework of falling real GDP and rising unemployment. According to the 2nd revision of the Greek Stabilization Program of May 2011, the deficit of the general government is projected to fall from 15.4% of GDP in 2009 to 2.6% of GDP in 2014. Yet, the debt to GDP ratio is projected to rise from 127.1% of GDP in 2009 to 153% of GDP in 2014. This is because of the negative differential between growth and the real interest rate, and the fact that Greece will continue having primary deficits until 2012. It is only in the fourth and fifth year of the program that Greece is projected to have substantial primary surpluses. Although the program appears front-loaded at first sight, in actual fact it also envisages a steep fiscal adjustment effort at the end of the program period as well.
Many international analysts have been advocating that Greece ought to further restructure its public debt, as, even if the stabilization program succeeds, it will be very difficult to persuade the markets that it has achieved fiscal sustainability. After all, the stabilization program itself envisages that the public debt to GDP ratio will reach almost 153% of GDP in 2014, from less than 100% in 2008.
In fact, a restructuring of Greek debt has already taken place, following the agreements of July and then October 2011. Under the terms of the so-called Private Sector Involvement (PSI), institutional investors such as banks, pension funds and hedge funds have agreed to exchange their holdings of Greek bonds for new bonds of longer maturities, at a steep discount. For the period 2011-2019, the total net contribution of the private sector involvement is estimated at 106 billion euros. In exchange, adequate resources to recapitalize Greek banks, if needed, have been pledged.
The question on everybody’s lips is whether the Greek program can succeed and under what conditions. This question acquires additional significance since the dual elections of 2012 that have ushered in a new three party government.
My answer is a qualified yes. The Greek program can succeed if Greece were to exercise long-term fiscal discipline as envisaged in the program and respect the rules of the stability and growth pact moving gradually into a budget surplus which will have to be maintained for a number of years. However, the program must undergo significant further adjustments that will speed up the recovery of the Greek economy.
Greece’s crisis is not simply a debt crisis. It is a dual confidence crisis, due to the mismanagement of the expectations of international creditors and domestic consumers and investors. Thus, to resolve the crisis, confidence needs to be restored on both fronts. The main difficulty of the Greek program is that it has so far failed to address the confidence crisis that has led to its adoption. The Greek program ought to be modified to break this vicious circle.
Three conditions are required for the restoration of confidence.
First, a clear pledge from all relevant parties that Greece will remain in the euro area. This is a commitment that has repeatedly been made by Greek political authorities, but the commitment lacks credibility as long as Greece’s partners do not back it up unequivocally. Unless the fear of Greece’s exit subsides, there will be the risk of further capital flight that stifles the Greek economy of liquidity, exacerbates the problems of the Greek banking sector, and causes a deepening of the recession.
The second is an effective tax reform that will restore the stability and predictability of the Greek tax system. This is a necessary precondition for a recovery of the Greek economy that will also help the fiscal adjustment effort. Greece can achieve the necessary fiscal adjustment with much lower business taxation, much lower property taxes and a much simpler income tax schedule for households than the one envisaged in the program. It is right and proper to rely more on consumption taxes, such as VAT and excise duties, in an economy where consumption is clearly excessive relative to the productive potential. A radical reform of the direct and property tax system, which will create expectations of stability and predictability, is probably the best tool for restoring the confidence of domestic investors, and thus allow the Greek economy to recover. The tax regime that was put in place at the end of 2009 is unduly complicated, contains significant disincentives to economic activity and investment, and is being revised far too frequently, almost every three months. All these elements work against both the recovery and the fiscal adjustment of the Greek economy.
The third and final priority would be a detailed program of reductions in public expenditure that should be the main tool of further fiscal consolidation. The program should include loss making public enterprises, local authorities, the administration of the social security system, health and education. This is the most difficult condition as it will involve hitherto untouchable areas, and requires detailed planning and a clear political strategy to implement it. However, it is much more central for the fiscal consolidation effort than any of the other two conditions. Structural reforms should be concentrated in this area as a matter of the highest priority. Structural reforms that do not directly contribute to the fiscal consolidation effort could be introduced more slowly, without significant risks.
The first sign of success will be the stabilization of the debt to GDP ratio. Under the current program this is not envisaged before 2014. This is due to the prolonged and deep recession, which serves to destabilize the debt to GDP ratio. Under current projections, the recession is set to continue well into 2013. To address the dual confidence crisis, the Greek program ought to be revised in a way that enhances its credibility, and produces some early results. So far, both Greece and its European partners have failed in restoring confidence. This does not mean that they cannot learn from past mistakes and eventually succeed. This is possible, if the Greek program is adjusted so that the recovery of Greece’s economy is speeded up and its credibility enhanced. This would be good for both Greece and the rest of the world.