Monday 24 October 2016

Even with a debt deal, Europe's Greek economic experiment looks set to fail

Published 25/06/2015 | 02:30

A bather leaps from a rock into the sea on the coast south west of Athens, Greece
A bather leaps from a rock into the sea on the coast south west of Athens, Greece

Greeks have had seven years of economic torture yet more financial pain will be required regardless of whether they do a deal with their creditors in the short term.

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A press release announcing a breakthrough deal in negotiations will not convey the long hard road that still lies ahead for the country.

No deal would plunge the country into even deeper uncertainty.

Greece joined the EU in 1980 with the value of economic activity per person at just over half what it was in Germany. Before the crash in 2008 it had reached two thirds but by 2014 it had fallen back down to less than half. And that is €200bn in EU funds later.

The obvious argument made by some is that Greece is not working economically and cannot be fixed unless it gets a massive write-down on its debt.

But that is not entirely true. In 2009 the Greek government was spending 10pc more than it took in, before it paid any interest on its €300bn national debt. Five years of austerity meant last year, it took in 3pc more than it spent, excluding interest payments. That is quite an achievement.

But it still owes just over €300bn despite getting a write-down of debt in 2012.

Its interest bill is relatively low, running at an average of below 3pc and repayment terms have been pushed back out for much of it. So last year Greece paid out around €5.5bn in interest payments on its debt. Ireland paid out €7.5bn on our debt off a smaller GDP.

So what is wrong? Its economy is far too dependent on domestic demand. It is not a big exporter. The services sector, mainly tourism and shipping, accounts for around 80pc of GDP. Manufacturing comes second with 16pc and agriculture is third with 4pc.

So, Greece needs Greeks to spend money at home and tourists to keep coming in big numbers. Greek buying power has been decimated. It has slashed 200,000 public sector jobs. It has cut pensions by 25pc. It has an unemployment rate of 27pc and youth unemployment of over 50pc. There isn't enough money swashing around the economy at home, to balance the books, meet interest payments, pay down debt and re-build investor confidence.

Tourism is its big exporting hope and it has been performing well as the country remained very cheap for foreign visitors. This industry has remained resilient, particularly in the wealthier Aegean Islands, despite a fall-off in bookings from Germany.

So if the Syriza-led government wants to collect more money in VAT it could charge a higher rate in the islands, which are better off, and keep rates lower elsewhere. A lot of it would come from tourists anyway.

But that is totally unacceptable to government politicians from those regions, who could walk out of government triggering new elections. This is a major domestic political problem for Prime Minister Alexis Tsipras.

Despite pension cuts, there is a view that the government is still spending too much money on pensions. For example, the pension of a 55-year-old retired senior police officer is about €1,650 per month. A lecturer working in a university earns about €1,200 (net after tax).

There are now just under 700,000 public servants working yet nearly 500,000 retired public servants on pensions.

For Syriza, further pension reductions have been a no-go area because they argue that many extended families of the pensioners are now relying on them. Instead of more cuts it has offered to extend the pension age to 67.

Filling up the state coffers to pay the bills has become hugely problematic when 200,000 people have emigrated, wages have been cut and unemployment remains incredibly high.

The more the Greek government grabs, the more it takes out of domestic spending. Greece needs to grow the economy.

A left-wing government in Greece will want to take more from those who have it. A more right of centre government here in Ireland, believed that business must be encouraged, the property market should be stimulated and the banks needed to be fixed.

So we cut back on essential services and are now facing criticism from international groups like the UN. But the economy is improving. Banks are stronger. Unemployment has fallen below 10pc.

The new debt deal proposals from Syriza include more business taxes on profits of SMEs and higher VAT rates in hotels and restaurants. In Ireland, we effectively subsidised restaurants and hotels by cutting our tourism VAT rate. We retained low business taxes and gave tax breaks to rich global investors to buy property. Not the stuff of social solidarity, but it may have worked economically.

We did also raid private pension pots to the tune of about €2bn and place higher Dirt tax on savings. Syriza has found that many of the very wealthy have pulled their money out of the banks and the country, so the government would struggle to get their hands on it.

Businesses are needed to create the jobs. Banks are needed to lend them money.

And this is probably one of the greatest obstacles of all. Greek banks have big problems. They are holding €15bn of Greek sovereign debt and rely on €110bn of money received from the ECB, to keep the ATMs going. They also lack enough solid capital.

Greek banks have built up what are called deferred tax assets, which they can use to reduce their tax bill on future profits. All banks use them, but some estimates suggest that these deferred tax assets make up nearly 90pc of Greek bank's equity.

Greek banks may well survive on short term liquidity, but it is hard to see them getting to a point any time soon where they could lend solidly into a recovering economy. Borrowing is a vital part of corporate activity.

If a deal is done, the Greeks will probably face a general election in the coming months as hardliners in Syriza withdraw support. An agreed deal will free up the last €7bn of bailout money, for as long as the Greek government delivers on agreed targets.

Domestic political difficulties or a weakening international economic environment could weaken its ability to do that.

There is an unreality about the European economic experiment that Greece has become. It is expected as part of the plan to deliver a solid primary surplus in the years ahead.

Since 1995 all the countries of the euro area reached a primary surplus of 3.6pc only once and that was in 2000.

Greece has some advantages that Ireland did not. Personal debt levels are low. They don't have the mortgage legacy we had.

But there are serious structural problems that still need to be fixed. For example, it has an army of 136,000 and spends more per capita on defence than any other Eurozone country.

Going for a complete default would have seen France and Germany exposed to the tune of €160bn. It could have defaulted on EU countries but not on private sector debt to help return to the markets more quickly.

But without reforms, in time it would be right back where in started again, only this time without the euro.

A deal will see Greece stay in the euro, but relations have soured, trust has broken down and sadly that legacy will remain.

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