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Saving Greece

GB Geo-Blog

Saving Greece

As reported in today’s New York Times: “The 16 countries that use the euro agreed on a financial safety net for Greece, combining bilateral loans from those European nations with cash from the International Monetary Fund.”  Under the deal, loans would be provided at market rates and offered with the agreement of all of these 16 countries.

To try to make some “sense” of this new accord, let’s look at the problems facing Greece. The Greek Government needs to borrow 53 billion euros this year, with at least 20 billion by the end of May, to re-pay maturing debt and finance its large budget deficit.

The Government of Greece had no difficulty in selling 5 billion euros in 10-year bonds at the beginning of March. Indeed, the issue was oversubscribed. However, Greece had to pay an interest rate of 6.3%. Greece might be able to borrow the 53 billion euros; however, the government will have to pay very high interest rates to do so.

Herein lies the first problem. These interest rates will make it very difficult for the government to achieve its goal of sharply reducing its budgetary deficit in three years’ time. If the market senses that the government will not be able to achieve its goal, and hence its borrowing requirements will continue to grow, interest rates for Greece will trend higher as investors demand large risk premiums to compensate for the higher expected default probabilities. Thus, a vicious circle ensues entrapping the Greek Government. Higher interest rates lead to larger deficits which lead to higher interest rates and so on.

A couple of weeks ago, Greek Deputy Foreign Minister Dimitris Droutsas pleaded on German radio for more visible support to enable Greece to borrow more cheaply. He insisted that Greece did not seek direct financial aid. In other words, Greece needed the eurozone countries to collectively guarantee new Greek debt. This should have been sufficient to significantly lower the borrowing costs for Greece.

But the eurozone countries, in particular Germany, insisted that Greece assume full responsibility for extricating itself from the mess it had created. So much for “all for one and one for all”.

Germany does have a point that the large deficits are playing a major role in escalating interest costs for Greece. Even with lower interest rates, interest costs could rise in line with the growing debt. Therefore, Greece has to tackle its fiscal problems.

Herein leis the second problem. The more drastic the restraint measures enacted and followed through by the Greek Government, the deeper and longer will be the recession in Greece. This will exacerbate the deficit problem as tax revenues decline and spending on certain social programs rise.

Consequently, Greece could face another vicious circle with dire repercussions for the economy and unemployment. The tighter is fiscal policy, the worse becomes the recession, and thus the more difficult it becomes for the government to achieve its budget targets. A recent Reuters poll showed economists in Greece were skeptical about the government’s ability to cut the deficit this year. Only 18 of 47 respondents said they believed Athens would achieve the promised target of a reduction of four percentage points of GDP.

Greece needs lower interest costs and some breathing room. The current proposal accomplishes neither for Greece. Dimitris Droutsas understands very well that what Greece needs is support form its EU “partners” – support in the form of loan guarantees. Greece needs what the major central banks did in 2008-09 to prop up the financial system. Loan guarantees will lower the country’s interest rates.

Greece also needs to be given more time to bring its fiscal house in order. With a continuing recession and rising unemployment, now is not the right time for Greece to take drastic fiscal actions. We didn’t see Germany or France or other major countries focus on their budgetary deficits and sacrifice their economies when the global recession hit its low point in the second half of 2008.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.


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