Grexit, ECB, Treaty of Lisbon and the Battle of Greece

by George Hatjoullis

The first round in the Battle of Greece has left a stalemate though Yiannis Varoufakis, the Greek finance minister, has demonstrated he is an able general. The objective of Syriza is simply to ease the pain of the Greek people and give the economy a chance to recover. They do not deny past mistakes or corruption. Nor do they seek to reverse structural reforms. Indeed they seem as keen as Berlin to achieve the reforms. The differences are in the pace of reform. The Greek people can only take so much pain and, as Varoufakis skillfully reminded Berlin, that the Nazi party is now the third largest in Greece is not unrelated. Surely, he exclaims, the German people can empathise with this! So what in practical terms are Syriza asking for?

The Greek economy should throw up a substantial primary surplus as was required by the original Troika recovery plan. Syriza has committed to permanent primary budget surpluses but not quite as large. This constitutes an easing of austerity. It makes sense because the economy is now pared down so far that even small stimuli will have disproportionate effects on growth and thus tax revenue ( I am going to spare you a digression on multipliers). A virtuous circle can replace the current vicious circle. Of course, the tax raising reforms must be continued and Syriza has committed to this. Sounds like win-win so what is the problem? The problem is the accumulated debt.

Reducing the primary surplus means paying down the debt more slowly. Recall that the primary surplus is revenue minus expenditure but before net interest on debt. A country with a lot of debt needs a primary surplus if it is to pay interest and not accumulate more debt. There is no point in Greece accumulating any more debt, so in order to to reduce the primary surplus (expand expenditure relative to revenue) they must also reduce the level of debt servicing. This implies a ‘haircut’ on outstanding debt. Herein lies the problem.

Syriza has suggested a debt restructuring. Specifically they have suggested swapping outstanding debt for perpetual bonds (that pay interest in perpetuity) and growth-linked bonds (where interest is linked to the Greek GDP growth rate). There is nothing intrinsically wrong with this except that the creditors may not agree or be able to agree. It depends on the detail. However, it is likely (though oddly not inevitable) that the net present value of the existing debt might exceed that of the bonds into which it is swapped. The creditors take a loss. Who are the creditors?

The Greek crisis has left Greek sovereign debt in the hands of the ECB, ESM, EU, IMF, banks and assorted private holders. The ECB cannot countenance any loss arising from a direct restructuring of its holdings. This would constitute monetary financing. Moreover, it cannot countenance swapping debt for perpetual debt as this too would constitute monetary financing. The growth linked bonds are also probably excluded for technical reasons though not in principle. Nevertheless, as the ECB cannot engage in monetary financing or anything Berlin might consider to be monetary financing, it is clear that debt held by the ECB cannot be included in any restructuring. This raises some difficult legal questions (pari passu clauses) and will bog down any restructuring. The IMF may also claim it must be repaid under its articles of association, which leaves the ESM and hapless EU. In the last analysis this debt is owned by the taxpayers of other EU states including heavily indebted countries such as Portugal, Cyprus, Spain and Italy. Greece is asking not just Germany but all the EU for some debt forgiveness (it has already been forgiven some debt by banks and private holders). Is this reasonable?

At first sight it is not a reasonable request. However, on closer reflection perhaps it might not be a bad trade for all (even Cyprus). The success of Greece in easing the pain of austerity will have positive effects in Greece through a virtuous circle. This will help all europe and establish the end of austerity as a valid and relevant policy tool. This does not mean everyone rushing off to borrow and run massive budget deficits again. It means everyone letting the belt out one notch and breathing a bit more easily. The virtuous circle will boost the EU economy more than ECB QE and reduce debt levels faster than the current trajectory has any chance of doing. Most important it will return economic prosperity to europe and set back the tide of political extremism and migration, which have fed on each other. Varoufakis is right. This is not about Greece, it is about europe.

Much has been said about the ECB’s lifting of the waiver on the use of Greek debt in normal monetary operations. Many journalists have claimed it was a political decision. It could just as easily be argued in reverse; that to not do so would have been a political decision in support of Greece. The waiver was conditional on certain terms that Varoufakis told Draghi he was committed to change. The waiver was thus correctly lifted and the funding of Greek banks shifted to ELA. The failure to allow ELA would be a political decision as it would de facto eject Greece from the eurosystem. The Treaty of Lisbon defines euro membership as irrevocable. This raises serious legal obstacles to Greece being ejected from the eurozone against its wishes, let alone by a decision from the central bank. Grexit is much spoken about but not easy to achieve.