Growth, not debt write-off, is the key
Greece has surprised many pundits by achieving a bigger-than-estimated primary budget surplus last year but it has a long way to go to reach a much higher level consistent with sustainable debt.
However, relying on fiscal orthodoxy to bring the debt ratio down to Maastricht levels is a risky route. It is not favorable to growth and is vulnerable to external and internal shocks – as recent political developments have demonstrated. Therefore, the government and the eurozone creditors should come up with a credible plan to boost economic growth in the medium term and deal more effectively with the debt overhang. Germany and Chancellor Merkel could play a constructive role to this extent.
It is not easy but it is possible for the Greek gross general government debt ratio to be reduced to a targeted 124 percent of GDP in 2020, as envisaged by the finance ministers of eurozone members in November 2012, from more than 170 percent last year. It requires that Greece attains a primary surplus of around 4 to 4.5 percent of GDP in 2016 and keeps it around that level for several years.
Having state revenues exceed spending, excluding interest payments, by about 9 billion euros in 2016 and beyond is a tall order. That said, last year’s 2.5- to 3-billion-euro surplus indicates it is possible, even if one takes out one-off items, given the GDP contraction by a revised 3.9 percent.
It should be noted that the 2013 figure does not include money spent for the recapitalization of Greek banks. There is another way to look at it by focusing on the primary balance adjusted for the ups and downs of the economy, the so-called structural or cyclically adjusted primary balance.
The European Commission has projected that Greece will post a primary surplus in excess of 7 percent of potential GDP in 2014 and above 6 percent in 2015, that is, if its economy is working on all cylinders. Prior to the crisis, the potential GDP growth was estimated between 2.5 and 3.5 percent but it must have come down since then and likely stands somewhere between 1.5 and 2.5 percent now. Assuming the economy picks up steam and grows by 3 percent annually or more from 2016 on, projected in the program, Greece can produce a primary surplus of 9 billion euros or 4-4.5 percent of GDP.
However, this is a risky route since any adverse external – i.e. recession in the eurozone – or internal events – i.e. politics – could derail the fiscal consolidation enough to miss the surplus target. This is more so since the process is supposed to last several years and entails the transfer of fiscal resources to the servicing of public debt, which is unlikely to be favorable for growth. In addition, this approach entails a long period of high debt ratios. It is therefore necessary that fiscal consolidation is supplemented by other means to deal effectively with the debt overhang.
It would be unrealistic to expect the ECB to make things easier for Greece or other debtors by setting a higher inflation target given German opposition to such a move. It is also unrealistic to expect a haircut on the Greek nominal debt since some creditors oppose it fiercely. It is, however, reasonable to expect that the Eurogroup will make good on its November 2012 promise for measures to provide debt relief. This will likely take the form of lower interest rates on the EU bilateral loans (GLF) of the first bailout, amounting to 52.9 billion euros, and the extension of maturities. It would be helpful in somewhat cutting annual interest payments and postponing the repayment of principal but it will not be effective in tackling the debt overhang issue.
Fiscal orthodoxy and the expected debt relief measures, however welcome, will not be enough to cut the Greek debt-to-GDP ratio drastically and drive it down to the Maastricht criterion of 60 percent in the long-run. So, the strategy should be supplemented by an investment plan to boost growth. This cannot be a Greek affair alone since there will not be enough resources from local banks, even after the second round of capital increases, and other domestic institutions to fund the projects.
Visiting Chancellor Merkel’s help in mobilizing available EU resources via the EIB and others, to fund such a plan, resembling the post-war Marshall Plan, in Greece and other southern countries, could boost growth rates, especially if it targets investments in tradable goods and services to prop up exports. This would also be good for northern countries since rising living standards in Greece and other countries, following the severe economic downturn, will make it possible for them to export more. Of course, such plans are easier said than done, as the recent experience with the Institute for Growth (IfG) illustrates. The latter, in which foreign banks such as Germany’s KfW and potentially the EIB along with Greek private investors would participate in its capital, has yet to operate. IfG, also called the Greek growth or investment fund, was supposed to already be up and running, providing mainly cheaper funding to small and medium-sized firms.
Fiscal consolidation is necessary for debt-ridden countries like Greece. However, history shoes us that large debt-to-GDP ratio reductions have relied more on growth rates and low borrowing costs than budgetary discipline. This is more so when the required primary surpluses to drive the debt ratio down are sizeable and have to persist for many years. Given the creditors’ unwillingness to write down the Greek public debt, the next best course of action is to boost growth via a major investment plan. Chancellor Merkel can be instrumental in this.
