26 January 2012 Last updated at 14:23 GMT
Tables are turning on Greek debt deal
The time for reaching a Greek debt deal is fast running out. That’s one thing everyone can agree on here in Davos.
But what’s less often noticed is that the balance of power around the
negotiating table has also shifted lately; against the Eurozone
institutions and politicians who most want to see a deal, and in favour
of the Greeks themselves.
There are three reasons for this shift.
First, the need for more debt relief for Greece has become even more blindingly apparent.
Second, it has become clear that the official sector has to contribute if it’s going to happen politely.
Finally, and more quietly, the Greek government has slashed its way to a
primary budget surplus: as of now it is only borrowing money to pay off
the debt. That could change things quite a bit.
Skyrocketing cost
Let me say a bit more about all of this. To see the need for greater
debt relief, you need only look at the skyrocketing cost of servicing
Greek debt. For all the “cheap” loans flowing to Greece from the
Europeans and the IMF, the Greek government had to pay 23% more in debt
interest in 2011 than in 2010.
Forecasts for its total debt relative to GDP get revised up almost every week and look less and less plausible.
The second new reality follows directly from the first. To put it
bluntly, the truth is slowly dawning that no “voluntary” arrangement to
cut the value of debt held by the private sector is going to provide
Greece with enough relief.
Either the haircut for the private sector has to be a lot more than
50%, in which case it is very unlikely to be classed as “voluntary” by
any stretch of the meaning of that word, or the stock of debt that’s
part of the deal needs to grow to include bonds held by public sector
institutions like the ECB, which has bought around €40bn (£34bn; $53bn)
of them.
As we have seen this week, Germany and the ECB are still dead set against this.
They say it might not be legal under the Treaty. They also think,
reasonably enough, that there’s an important principle at stake. If the
official sector runs into a burning building when the private sector are
all running out, the rescuers shouldn’t be the ones to get burned.
But, you might say, that is why firemen have trouble getting
insurance. It’s a dangerous line of work no matter how much protective
clothing you have.
Maybe it’s not fair, but if the Germans want their first – and
supposedly last – foray into “private sector involvement” to happen in
an orderly way, it’s looking as though they’re going to have to swallow
some losses for the ECB, or find some other way for the public sector to
be involved.
Ambitious debt reduction
You might ask why any of this strengthened the hands of the Greeks, as I suggested at the start.
One reason is that the IMF is now firmly behind a more ambitious debt
reduction. As we have seen this week, the IMF’s managing director is
also on Greece’s side pushing for public sector involvement in the deal.
But another key factor, which few seem to have tumbled to, is that
the costs to Greece of the government walking away from the table and
suffering a disorderly default have fallen noticeably since last summer,
at least when compared to any plausible (orderly) alternative.
The key to this is to look at the Greek government’s budget outturns for the second half of 2011, published earlier this month.
As Graham Turner of GFC Economics has noted, these show a real
step-change in the effort to cut spending and actually collect more
Greek taxes.
You’ll remember it was the Greeks’ inability to get a grip on
spending or taxes in the first half of 2011 that caused the big
overshoot in their deficit, and such paroxysms in Berlin and Brussels
(not to mention the markets).
The primary budget – excluding debt interest payments – for the first
6 months of the year had a deficit of €5.1bn, which was almost exactly
the same as the year before.
Tax revenues had fallen by more than 5%, year-on-year, and non-interest spending had risen by more than 8%.
That was when the fiscal equivalent of Eurozone special forces
parachuted into Athens as part of the second rescue package, with EU tax
officials seconded to the Greek finance ministry. If the numbers are to
be believed, they have made a massive difference.
In the second half of 2011 the latest figures show tax revenues up
1.4% year on year and non-interest spending falling by an impressive
7.4%. As a result, the Greeks seem to have managed a 1.8bn euro primary
surplus in that period: the overall deficit was still massive, but all
that borrowing was going toward debt interest, not domestic spending.
Less terrifying Here’s why this matters: traditionally,
countries that need a massive write-down of debt will try very hard to
avoid a disorderly default when they are still borrowing from the
markets to fund basic government services.
However, the balance of arguments shifts a bit, when they “only” need
to raise money in the markets to service their debt. Further budget
cuts, simply to pay investors their interest, are harder to defend
politically. And the immediate fallout for basic services of losing
access to the markets gets slightly less terrifying.
Don’t get me wrong. If it happens, as so many people now expect, a
full-blown Greek default would still be horrendous for its financial
system, and its domestic economy – at least in the short run. (That’s
quite apart from the impact on its eurozone neighbours. I’m only
thinking here about the implications for Greece.)
For all that, the balance of costs and benefits to Greece relative to
the current path is not what it was years ago, when it’s primary
deficit was 5% or 6% of GDP.
And, let’s face it, the stick-with-it scenario is not looking so hot either.
Earlier this week, the IMF’s chief economist, Olivier Blanchard, spoke eloquently about the dangers of the crisis.
He noted that one of the more pernicious things about the current
situation was that countries under pressure were doing the “right thing”
in terms of budget cuts, but were not getting rewarded for it, either
by the markets or by their supposed eurozone allies. That’s more than
unfair; it’s dangerous.
The irony is that Germany’s very emphasis on putting fiscal tightening
before everything else has actually now put Greece in a stronger
position to default.
If that is not what Angela Merkel intended to happen, she will almost
certainly need to give some ground in these debt negotiations to
prevent it. Assuming it is not already too late.
Stephanie Flanders
Economics editor
