Commentary: Greece in the financial crisis

Restoring credibility

Greece remains quickly without money and is obliged to borrow, although this just brought it in its current state. Although it may, still, borrow at an interest rate of 6 per cent, considering the dynamics of debt lately, it's hard to inset different future for the country than entering Greek default. Over the next few months, Greece will need 23 billion Euros


By OVIDIU PALCU
from Athens, GREECE


Greece faces the most difficult situation that has ever confronted a Euro zone country since the birth of the common currency in 1999. Everybody in the European Union seems to be scared - both within and outside the euro area. The main problem for Greece is to restore its credibility. It will not be easy.

Since its bid to enter the Euro area, Athens has been responsible of cooking the figures of its economy. Also serious concerns are being raised about the impact of the ongoing recession in Greece on the political and economic situation in the neighboring Balkans. This could also mean a spillover of the recession from Greece to the neighboring economies. Greece is not only a major investor in the Balkans but also a donor and host to several hundred thousand economic migrants from the region.

The plan formulated by the European leaders to support Greece has failed to have the desired effect of reducing the cost of credit for the most indebted country in the euro area. Yield ten-year bonds issued by Greece increased by 25 basis points from March 25, when European leaders announced plans to aid Greece, reaching 6.525%, the highest in the last month. The yield fell slightly, but the cost of lending is still double that of Germany.

Reducing deficit

In the context in which borrowing costs continue to rise, EU leaders want to put into operation a mechanism but has not been detailed yet. Thus, they should decide the role of the International Monetary Fund (IMF) rescue plan, and German Chancellor Angela Merkel has to face opposition from public opinion in Germany to Greece to save taxpayers money. Until now, European officials had expected yields to fall, in the context in which the Athens government plans to reduce deficit to 8.7% of gross domestic product (GDP) this year from 12.7% in 2009.

President of European Central Bank (ECB), Jean-Claude Trichet, said that investors will gradually recognize steps taken by Greece. Financing facility, consisting of bilateral loans from the IMF and the Euro area countries, will be implemented as a last resort, if Greece has no other financing options. Greek Prime Minister George Papandreou, who must get 11.6 billion Euros in late May, said the plan is "very satisfactory". Some analysts say it is too early to say the EU plan has failed, in the context in which the latest austerity plan, announced on March 3, has not yet been implemented.

Greece remains quickly without money and is obliged to borrow, although this just brought it in its current state. Although it may, still, borrow at an interest rate of 6 per cent, considering the dynamics of debt lately, it's hard to inset different future for the country than entering Greek default. Over the next few months, Greece will need 23 billion Euros. For this purpose, among others, the Greek government will sell bonds in the United States hopes to gain 5 to 10 billion dollars from investors to cover their rates by ten billion dollars that has to pay in May. Thus, Greece is likely to get money for its needs from international markets, giving Euro zone excuse not to intervene to save the country.

EU leaders agreed not to offer financial support to Greece unless it fails to get money from other sources. But in this process, Greece maybe is forced to fail. As a member of a large monetary union, Greece has the advantage of money, but the country can only improve competitiveness by maintaining a relative disinflation than the average Euro area, which means, in fact, deflation. Therefore, the Greek government will need not only to reduce its huge budget deficit, but must do so in terms of a possible deflation, leading to a decrease in growth below zero. And this will jeopardize the debt reduction program, both in the public environment, as well as for private. It is almost impossible for Greece to balance the debt to GDP ratio, no matter how hard they try. The tough measures proposed by Greece include an overhaul of the tax system, spending cuts, a hiring freeze on civil servants and salary caps for the highly-paid. Greece has pledged to bring its 12.7 percent budget deficit down to 8.7 percent in the first year of a three-year crackdown.

Scenarios for Greece

To exit from this situation, one of the things should happen: The first and the most optimistic would be a significant drop in reported U.S. dollar value of the euro and a strong economic recovery in the Euro area. This could sustain the growth rate of Greece. A second possibility would be for Greece to gain access to low interest loans from the European Union and International Monetary Fund. On the other hand, there should be a debt restructuring and to prevent deflation. A third solution would be for Greece to leave the Euro zone, which is unlikely, and the fourth scenario might be entering default.

Passing through these scenarios, we realize that one is very unlikely, and the second was excluded by the leaders. If a debt restructuring, European banks would need financial support and, although the third option would agree most Germans, Greeks will not make the mistake to leave the Euro zone. This left only the last variant, which is to remain in the Euro zone and enter default. This would throw the Euro area in a crisis that could put an end to monetary union. Portugal and Spain have similar problems, but on a better scale. Spain will be forced to go through a period of disinflation and deflation, which will produce huge private sector debt, indefinitely prolonging the crisis in this country. Portugal, like Greece, is suffering from debt problems both state and private.

For the moment, Greece fails to manage debt well, allowing the country to survive. On the other hand, negative effects of the dynamics of debt and deflation have not yet began visible, which will become inevitable once, and then will begin the process of debt reduction. Thus, even if Greek economy would grow by two percent this year, which is unlikely, it will be very hard to avoid entering into default, even if it does not happen this year. It is not only Greece's credibility that is on the line. Also at stake is the credibility of a European mechanism unable to defend itself from felonious behavior by its country members. The lack of credibility of Greece undermines the credibility of Europe. And the two must be restored together.



(Published: 10.04.2010.)