The Daily Update - Greece and Eurozone

The German word ‘schuld’ means ‘debt’ but it also translates to ‘guilt’ and ‘shame’ and perhaps goes some way to explaining Germany’s more rigid austerity driven approach to Greece and its debt.  In contrast, the IMF has been extremely vocal about the need for ‘debt restructuring’ and a dose of reality in the economic projections for its participation in any Greek bailout.

Understandably, both the IMF and Eurogroup have insisted upon some credible structural reforms in return continuing to disperse yet further bailout payments, although the IMF’s and the Eurogroup’s views on the appropriate degree of austerity and realistic budget estimates still seem some way apart.  The IMF is working with a more pessimistic set of forecasts than the Eurogroup and is sceptical about the primary surplus target with Christine Lagarde stating: “The 3.5% in the short term might be achievable by some heroic, and I really mean heroic, efforts on the part of Greece and the Greek people.”  But “what we find highly unrealistic, on the other hand, is the assumption that this primary surplus of 3.5% can be maintained over decades. That just will not happen.”  The IMF thinks it is more realistic to assume a primary surplus target of 1.5% (by 2018) with debt relief.

Some progress has been made on the IMF request for contingency austerity measures to be legislated for in the event that the Eurogroup ignores the IMF and still runs with the 3.5% target; Jeroen Dijsselbloem stated Greece will legislate a mechanism to generate the €3.5bn of additional savings (~2% of GDP) and this “approach was agreed and supported by the IMF today in the meeting.”  However, the problem is that the IMF thinks the additional savings “would only be credible based on long overdue public sector reforms, notably of the pension and tax system.”  The IMF does not support Greece’s proposed “short-term across-the-board cuts in discretionary spending…or transitory cuts in pension and wages.”

The latest Eurostat figures showed Greece’s government debt to GDP ratio easing to 176.9% at the end of 2015 and a primary surplus (excluding interest payments and other one-off items) of 0.7% of GDP versus an adjusted primary deficit target of 0.25% under its bailout program. If interest repayments and the bank recapitalisation are included the deficit was 7.2% of GDP.  But the IMF’s criticism of the lack of sustainability in the programme is even echoed by the ESM’s debt sustainability analysis which, in the absence of debt relief under their baseline scenario, show Greece’s financing needs escalating from 9% of GDP in 2022 to 19.5% by 2040 and 24.3% by 2060.

The IMF’s call for debt relief has been further escalated ahead of the Eurogroup meeting with a leaked letter from Christine Lagarde warning “for us to support Greece with a new IMF arrangement, it is essential that the financing and debt relief from Greece’s European partners are based on fiscal targets that are realistic because they are supported by credible measures to meet them”.  Earlier this week ‘debt restructuring’ was finally discussed by the Eurogroup.  But any restructuring still appears ‘Germanic’ in its approach focusing more on refinancing, interest rate holidays and lengthening of maturities rather than any write-down of the principal amount. 

For us the Greek dilemma is an illustration of the problem of creditor and debtor nations entering into a currency union, particularly in the absence of a European Treasury with a unified fiscal policy and fully functioning redistribution mechanisms.  As it stands, the adjustment process to reduce imbalances has taken the route of austerity which has hit the debtor nations hardest in terms of weak growth and deflationary pressures, exacerbated by the lack of debt write-offs.  Budgetary stimulus to boost demand has been lacking in the North and has not been helped by Germany’s balanced budget target despite it having a sizeable savings and current account surplus.  Faced with this backdrop, it comes as little surprise the EC Spring forecasts downgraded Eurozone inflation to 0.2% for 2016 with 2016 GDP growth forecast to languish at 1.6%, down from 1.7% in 2015.