By Dimitris Kontogiannis

The markets have taken a more positive view on Greece in the last few months on the heels of some good macroeconomic news, the disbursement of long-delayed bailout funds and statements by creditors underlining their willingness to keep the country in the eurozone. But this bright side cannot hide the reality of a deepening economic crisis, leading to even lower living standards and rising joblessness. In this regard, the likely increase in private sector arrears to the state appears to be overtaking political instability as the most important risk to the adjustment program.

The main index of the Athens bourse has more than doubled from seven months ago when the conservatives won the repeat elections and Prime Minister Antonis Samaras formed a coalition government with PASOK and moderate Democratic Left last June.

Even the more conservative fixed-income investors joined the party. The average price of the Greek strip, as the post-PSI basket of government bonds is known, more than doubled during the same period as well. The main catalysts are two. First, the explicit statement by ECB’s chief Mario Draghi to do whatever is necessary to save the euro in late July, followed by the unveiling of the OMT program a few weeks later. Second, and most important, the impression that Chancellor Angela Merkel has decided to keep the country in the eurozone, at least until Germany’s general elections in the autumn.

This impression was boosted by an unusual number of positive statements about Greece’s efforts by German, other EU and IMF officials, the disbursement of bailout funds and new debt relief measures taken by the EU. Moreover, new data showed that the country was on its way to attaining the general government primary deficit target of 2.4 billion euros or 1.2 percent of GDP in 2012, while the current account deficit was likely to shrink by more than initially projected, that is below 4 percent of GDP, based on preliminary figures spanning the January-October 2012 period. The prices of bonds and stocks rallied to take into account the ensuing reduction in the probability of a Greek exit from the euro.

But there is a flipside to this sense of euphoria shared by the markets and officials in Greece and abroad. It is the dismal economic reality at home, which is bound to get worse this year as a fresh bout of fiscal austerity measures worth about 11 billion euros takes effect. This is more so as private-sector wages continue to compress on rising unemployment and the fallout from last year’s labor market reforms.

The reality is that a decreasing number of people, about 3.6 million, are working to support the rest of the 11 million population. At the same time, the unemployment rate keeps hitting new records, with the latest data putting it just below 27 percent. This implies that unemployment in the private sector is much higher since layoffs in the public sector are rare. What’s worse is that more than half have been unemployed for more than 12 months, meaning they have no access to the country’s small unemployment benefits, while joblessness among the young continues to climb, forcing the most educated and perhaps talented to seek a better future abroad. The latter deprives Greece of precious human capital, contributing more to the aging of the population, and a lower potential GDP and economic growth rates ahead.

So far, the tough economic times have not led to social upheaval as some analysts had feared – the most violent demonstrations took part early in the program – but it is hard to gauge what is going to happen in coming quarters. However, anger and declining livings standards are not likely to lead to some kind of social uprising even if the unemployment rate remains elevated in our view. The case of Spain, where unemployment has been high for decades, may not be representative of Greece but it is indicative of what may happen.

However, the economic crisis could derail the economic adjustment program via two other routes. First, the tough economic reality may boost the anti-bailout political forces, which could lead either to early elections or a general paralysis in the civil service and the erosion of confidence in the private sector. However, recent polls show the government’s emphasis on law and order appears to have benefited the conservatives, which have pulled slightly ahead or tie with leftist SYRIZA in the first place. In addition, the right-wing Independent Greeks party, which has been dubbed as a possible partner for SYRIZA in an anti-bailout government, appears to be losing ground. Moreover, the poor performance of the conservatives’ two junior coalition partners means it is not in their best interest to topple the government. So, concerns about an increase in political risk have not materialized so far but it is still too early to make a call.

At this point, the biggest risk to the program appears to be the inability or/and unwillingness of a growing number of households and companies to pay their taxes and social contributions in addition to serving their loans. Arrears to the public sector grew by more than 13 billion euros last year and the deepening recession does not bode well for this year. On the other hand, the state owes more than 9 billion euros to the private sector and optimists hope the repayment of some 7 billion will enable individuals and companies to honor their obligations.

History has taught us that markets tend to be ahead of the curve and an improvement in macroeconomic fundamentals, such as the budget deficit and the current account balance, tend to precede a rise in living standards. However, the ordeal of excessive austerity still has a long way to go in Greece without, likely, a supporting external economic environment this year and more restrictive fiscal measures in queue for 2014-2016. In this context, the risk that an increasing number of people faced with hardship may be unable to pay their taxes and contributions could turn out to be a bigger threat to the program than the much-heralded political risk.