Greece: new possibilities

by George Hatjoullis

After spending a pleasant week in Athens I return to discover there is optimism on the outlook for Greece. The government has expressed its confidence that the worst is over. Fitch has upgraded Greek sovereign debt to B- from CCC.

A closer look suggests optimism is premature.

English: The government debt of Portugal, Ital...

English: The government debt of Portugal, Italy, Ireland, Greece, United Kingdom, Spain (PIIGGS) against the European Union and Eurozone 2002-2009. Data from Eurostat. (Photo credit: Wikipedia)look suggests optimism is premature.

Greece is in the 5th year of recession. GDP fell 5.3% year-on-year to the first quarter 2013. Fitch seems somewhat inconsistent in the upgrade given that they also forecast that the debt-to-GDP ratio will reach 180% next year. This hardly constitutes a sustainable debt path and raises the very serious possibility that another bout of debt forgiveness will be necessary. However, the debt is largely in official hands so such debt forgiveness constitutes a fiscal transfer from eurozone partners. The whole crisis has come about because of a desire to avoid such overt transfers, so this would be odd indeed. Perhaps it signals a new possibility?

Greece is not going to be able to grow its way out of debt. GDP will at some point stop contracting and start to expand again. However, the pace of expansion will depend upon private sector investment. It is unclear what kind of pace of expansion can be expected but it is unlikely to be sufficient to clear such the debt pile any time soon. Privatisation of public enterprises will, in principle, reduce the debt burden significantly but even on the most optimistic assumptions Greek sovereign debt levels will remain a burden. Debt forgiveness will be necessary at some time and in some form.

Berlin opposes fiscal transfers. It does so for two reasons. The first is the sound desire to avoid moral hazard. The second is the slightly more dubious need of Angela Merkel to negotiate an election. Once the election is over it is possible that Berlin may consider fiscal transfers. However, the issue of moral hazard remains.

There has been a distinct change in attitude within the eurozone towards austerity in recent weeks. The self-defeating nature of synchronised austerity has begun to dawn on even the most die-hard fiscal conservative. The remaining problem of moral hazard may also have been resolved.

The austerity was not simply about fiscal retrenchment but also a tool for reform. Indeed I argued several years ago that what Greece needed was not austerity but reform. It was judged in Berlin, perhaps correctly, that Greece would not reform willingly and that a degree of coercion was needed. The austerity served as a tool of coercion. Greece has begun to reform.

The interesting possibility is that, as Greece reforms its institutions to eliminate such problems as corruption, nepotism and tax evasion, the emphasis on austerity will weaken and the fear of moral hazard diminish. In this context there is scope for some blurring of the issue of fiscal transfers and official debt forgiveness. On this view Greece’s salvation lies in its own hands. The sooner it reforms its institutions and practices and puts in place safegurads against any future fiscal laxity then the sooner it can move to a sustainable debt path irrespective of the private sectors capacity to generate growth and employment. Indeed such reforms can only enhance the competitiveness of the private sector.