Friday 28 October 2016

Expect a harder default for Greeks... and less democracy for the rest of us

Constantin Gurdgiev

Published 11/07/2015 | 02:30

An anti-austerity protester stands in front of Greek parliament in Athens
An anti-austerity protester stands in front of Greek parliament in Athens

With a whirlwind of deadlines, summits and presentations this week, the years-long saga of the Greek crisis has moved from one non-solution to another. Its latest iteration is the Athens-proposed Bailout 3.0 unveiled on Thursday night. For all the rhetoric surrounding its specifics, as well as the uncertainty of its adoption, two things are clear. One: for Europe and Greece, the cost of addressing the Greek insolvency is not going away. Two: the process of restructuring of the euro area institutions, launched in recent months in response to the latest flaring up of the Greek crisis, is here to stay as well.

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The immediate problem with the latest set of proposals from the Greek government is the German-led, majority of the EU-supported, insistence on not allowing any upfront writedowns of debt.

Contrary to what we hear from Irish and other European leaders, the arithmetic of Greek debt is brutally simple. Athens's liabilities cannot be repaid, no matter what reforms are put in place. The Bailout 3.0 package simply means there will be more of the unrepayable debt to manage than before.

The IMF provided a clinical assessment of the situation in its recent report.

As noted by the Fund, failure to achieve 2014 fiscal objectives and the reduction in deficit targets for 2015-2016 means that Greece will require some €13bn in new funding through 2018. The collapsed banking sector made 2012-2015 privatisation plans infeasible, requiring €9bn more in financing. The economy in a free-fall and accumulation of government arrears add more problems. Per IMF estimates, even if Greece were to adopt all structural and austerity measures as outlined in the latest bailout plan, the country will still need to raise roughly €52bn in financing between October 2015 and December 2018. Crucially, the IMF assessment was based on the data through April-May 2015.

This week, the Greek government requested €53.5bn in new 'assistance', barely covering the IMF-estimated 2016-2018 funding gap. This leaves unaddressed economic and fiscal losses sustained over the last month and a half, and estimated at around €4bn. The request also leaves out repayments of debt maturing in July-September plus June arrears, amounting to over €15.6bn.

Neither do they cover recapitalisation costs of the insolvent banking system, nor the costs of dealing with banks' liabilities to the Eurosystem currently at €90bn and likely to rise in the short run. Even with savage deposits bail-ins, most likely to follow any agreement with the EU, Greece will need an additional €20-26bn in funding through 2018, on top of the requested €53.5bn.

Were Greece to receive new funds, its debt to GDP ratio will balloon to over 200pc in 2016-2017 - well beyond the worst case scenario projected by the IMF.

Currently, 67pc of Greek debt, or close to €234bn, is held by euro area institutions, excluding banks' own liabilities.

If the new Greek proposals are accepted, this is likely to reach over €300bn.

The mathematics of addressing the Greek crisis is ugly, one way or the other. The country is insolvent, its economy is incapable of financing current debts, let alone assuming new liabilities, and its people are voting loud and clear against Europe-imposed policies.

Which means that Greece will have to default even harder in the future.

The cost of avoiding Grexit now, without immediate writedowns of Greek debt, means setting ourselves up for another crisis in 2018-2020.

However, the Greek Bailout 3.0 costs reach beyond pure financial considerations.

One basic pillar on which the euro has been established is the young currency's credibility.

This credibility is, in part, anchored to the 'no exit' clause for the member states.

In part, it also rests on an implicit assumption that the states do not default on their international obligations.

Following last month's failure of the Greek government to repay June's €1.6bn IMF tranche, the second commitment is now 'soft' at best.

Come next week, Greece is risking a default on an additional €452m in IMF debt, as well as some ¥20bn worth of the 20-years-old Japanese-yen denominated debt.

On Tuesday night, the Eurogroup put a large question mark over the 'no exit' clause as well, by openly admitting that the EU Commission has prepared a detailed Grexit plan.

Thus, whether or not Greece stays in the euro is no longer material: the theory of inviolable euro membership has been bent and broken, for all to see.

Germany and France, as well as a handful of other 'core' members states, understand this. They also understand the imperative to shore up the rules system to regain credibility lost in the crisis.

This is precisely why, in recent weeks, we have witnessed a large-scale push for effective federalisation of the euro area.

The Juncker Plan, the Five Presidents Report, and a host of accompanying documents have outlined clearly a path toward a quasi-political and fiscal union for the eurozone.

Building on the crisis experience, the events of the last six months have provided an excuse for enhanced political and fiscal consolidation of Europe. This consolidation will start with creation of the EU Treasury, replete with its own autonomous powers of taxation.

The remit of Brussels over budgetary and economic policies of the member states will be expanded beyond the already egregious 6+2 Pack framework and the Fiscal Compact Treaty.

In the longer term (but before 2025), the process of reforms is bound to culminate in a creation of a federal tax system.

There is a certain inevitability to this development. The political trilemma of monetary economics postulates the incompatibility of independent monetary policy, free capital mobility and national democracy.

In simple terms, the euro area will, in the longer run, be forced to make a choice of only two of the three objectives above.

With free capital mobility being a cornerstone of the modern globalised economy, Europe's only choice is either preserving democratic institutions or preserving a Germany-dominated monetary policy independence.

No prizes for guessing where the Greek crisis is leading us to.

Irish Independent

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