Greece and the EU: Battle of the (third) bailout

Battle of the (third) bailout

THOSE looking for good omens about Greece's future in the euro zone will have been heartened by the news last week that the European Central Bank would soon print euro banknotes bearing a new design with the portrait of Europa, the figure of Greek mythology who was abducted by Zeus disguised as a white bull.

Would the ECB be issuing new five-euro notes inspired by a Greek foundation-myth—indeed would it be naming the whole series of banknotes after Europa—if Greece were about to be kicked out of the euro? Surely not.

For some months now it has been clear that Angela Merkel, the German chancellor, did not want to eject Greece if she could possibly help it. She even made a trip to Athens to make the point (see my column here). It is equally clear, however, that Germany and the other creditor countries do not want to commit more billions of euros to pull Greece out of its economic death spiral.

So when finance ministers of the euro zone met in Brussels on November 12th to discuss Greece, they were in a quandary.

For once, they showered Greece with praise for its readiness to cut its budget and cut it again and again (see our story on the latest budget) and to embark on structural reforms. Olli Rehn, the EU's commissioner for monetary affairs, said it was "time to debunk" the idea that Greece had not reformed: it has cut the deficit by far more than required under its original bailout in 2010; labour reforms were improving competitiveness (by reducing wages); and the health service now boasted one of the most modern electronic prescription systems in the world.

The euro zone agreed (see statement here) that Greece could have two more years to meet its fiscal target, shifting from 2014 to 2016 the date by which it should achieve a primary budget surplus (ie, before interest payments) of 4.5% of GDP.

But the ministers could not agree on how to finance this extension and, more importantly, how to bring down Greece's Olympian-scale debt burden. That will be left for a new meeting on November 20^th. And if finance ministers cannot reach a final deal, the matter will inevitably have to be taken up at the European summit that is supposed to discuss the EU budget two days later.

This timing delays yet again the disbursement of the much-delayed tranche of euro-zone aid, worth €31.5 billion. Greece has to refinance €5 billion worth of T-bills falling due on November 16^th, but the ECB will not accept more than about €3.5 billion worth of them as collateral under the current ceiling. This reduces the incentive for Greek banks to buy more bonds. But Mr Rehn said the banks had more money than previously thought, and were expected to buy the bonds anyway. "There will be no problem with the roll-over," he declared.

The scale of the economic damage in Greece is set out in a leaked assessment (hat-tip FT) by the "troika" of experts from the IMF, the European Commission and the European Central Bank. Many of the problems may have been caused by Greek delays and resistance. But much of the harm was done by the uncertainty, often fed in Germany, about whether Greece could remain in the euro zone. Even so, the authors seem caught by surprise by the depth of the recession, now in its fifth year, with no return to growth expected before late next year.

The Greek prime minister, Antonis Samaras, may have claimed that the latest austerity measures worth €13.5 billion (about 7% of GDP) for 2013-2014, the toughest yet, would be the "last and final" round of cuts. But the troika report says that further austerity measures worth €4 billion will be necessary in 2015-2016. The slow progress of privatisation does not help.

All told, extending the bailout by two more years means Greece will need to borrow some €32.6 billion more from its euro-zone partners. That amounts to a third bail-out.

Even if this extra help is agreed somehow, Greece will be far from safe. The previous bailout, which included a big haircut on private bondholders (known as Private Sector Involvement, or PSI), was supposed to bring Greece's debt below 120% of GDP by 2020. That will be missed by a wide margin.

Quite how wide is still a matter of dispute. The "debt sustainability analysis" has been omitted from the troika's report. But sources say the IMF reckons Greek debt will be around 160% of GDP in 2020, while the European Commission puts it lower at about 140% of GDP. Massaging of the figures, which are sensitive to forecasts of the rate of economic growth (or Greece's case, of shrinkage) and the interest rate should eventually reconcile the two.

Jean-Claude Juncker, president of the Eurogroup of finance ministers, tonight offered another fudge. He said the target date to bring debt down to 120% of GDP could be shifted to 2022, given that Greece is being allowed an extra two years to meet its fiscal target. In doing so he disagreed publicly with Christine Lagarde, the IMF's chief, sitting next to him, who insisted that the 2020 date should be kept.

Either way it is clear that Greece's debt will at the very least need to be rescheduled, for example by lengthening maturities or lowering interest rates. The IMF seems to be holding out for outright forgiveness of debt now held mostly by the official lenders, hence the euro-jargon of Official Sector Involvement (OSI). This is politically explosive in Germany and other creditor nations, because it would mean admitting that money lent to Greece had been lost forever.

But consider the advantage: by taking a direct hit, the countries of the euro zone would be giving a strong signal that they intend to keep Greece in the family. Restoring confidence in Greece might be even more valuable than money.

Goay Joe Lie

Director of Joe Lie Beauty And Cosmetics