Greece’s Unhappy Anniversary
Thursday, May 12, 2011
One year after having received a $150 billion bailout package from the International Monetary Fund (IMF) and European Union (EU), Greece is back at the public trough asking European taxpayers for another bailout package that might see the country through 2012. This will justifiably prompt taxpayers in Europe’s northern countries to ask whether there will be any end to requests that they prop up basically insolvent Euro-member countries like Greece, Ireland, and Portugal. It will also prompt them to ask whether northern Europe would not be better served with Europe’s peripheral countries out of the euro.
It was not supposed to turn out like this. Under the IMF-EU adjustment program agreed last year, Greece was meant to put its budget deficit-to-GDP ratio on a clearly declining path with a goal of stabilizing its debt-to-GDP ratio at around 160 percent. At the same time, structural measures were supposed to restore confidence that would allow the Greek economy to recover by the end of this year. This was supposed to have laid the basis for Greece’s government to re-access capital markets by 2012.
It is now patently clear to the markets that Greece’s public debt ratio is far from stabilizing.
Markets clearly think otherwise, as they indicate by requiring around 25 percent a year to hold two-year Greek government paper. Such high interest rates imply that the market is now assigning a high probability that Greece will default on its sovereign debt obligations within the next two years, notwithstanding the massive bailout package that Greece has received from the IMF and EU.
It is now patently clear to the markets that Greece’s public debt ratio is far from stabilizing, since its economy is contracting at a much faster pace than the IMF had anticipated, while its tax revenue collections are literally collapsing. Over the past 18 months, Greece’s real GDP has contracted by 8 percent, contributing to the currently more than 10 percent rate of decline in its revenue collections.
The essence of Greece’s current economic predicament is that through years of government profligacy it built up outsized public-sector and external imbalances within the most rigid of exchange rate systems. Stuck within the euro, Greece no longer has the ability to promote exports through currency devaluation, which would have helped offset the adverse impact of savage fiscal tightening on economic growth. It is now finding out how very costly it is to try to correct these large imbalances within the straightjacket of euro membership.
Stuck within the euro, Greece no longer has the ability to promote exports through currency devaluation.
It is difficult to see how additional lending to Greece, whether private or official lending, will put its public finances on a more sustainable path. And that remains the case even if that lending were subject to even more austere budget measures. If Greece’s experience over the past year with fiscal austerity within the straightjacket of euro membership is any guide, one would expect that additional fiscal austerity would only lead to an even deeper Greek economic recession. That in turn will further complicate Greece’s tax revenue collection problems and further erode Greece’s already frayed political willingness to stay the course.
It seems that Greece is rapidly reaching the point that any further belt tightening to restore fiscal balance would entail economic and social sacrifices too onerous for the political system to bear.
Greece’s European partners should recognize that Greece’s public finance problem is fundamentally one of solvency rather than liquidity, and should stop pretending that another big dose of public lending will prevent Greece from eventually defaulting on its debt obligations. At the very least, if they do choose to keep propping Greece up with public money in an effort to forestall a Greek default, they should level with their electorates as to how costly a proposition this will be for the European taxpayer. For, in the end, European taxpayers will be left holding the bag.
Desmond Lachman is a resident scholar at the American Enterprise Institute.
FURTHER READING: Lachman previously wrote about the eurozone in “Repeating Europe’s Charade,” “Till Debt Do Us Part” and “What Might Trigger the Euro’s Demise.” Lachman also wrote “Do Not Blame the ‘Herd’ for Greece’s High Borrowing Costs,” “Shooting the Messenger European Style,” and “Lessons from the U.S. from the European Sovereign Debt Crisis.”
Image by Darren Wamboldt/Bergman Group.