Good news, but targets remain elusive
Greece is the major beneficiary of the decisions taken by European leaders on March 11, but this is not cause for celebration because they do little to address the country?s two most important issues: economic growth and public debt reduction at a time when budget deficit figures show a clear deterioration.
The informal eurozone council meeting last Friday offered more than the markets — which had thought that major decisions would not be announced until the March 24-25 EU summit — had expected.
The most unexpected announcement included a lower interest rate to Greece, the increase of the lending capacity of the European Financial Stability Facility (EFSF) to 440 billion euros from an effective 250 billion euros currently, and the green light to the EFSF and the European Stability Mechanism (ESM) to buy bonds issued by countries with bailout programs in the primary market.
As far as Greece is concerned, the EU will extend the maturity of the existing loan to a four-year grace period from two, and a six-year repayment period from three. This means that the average maturity of the loan is 7.5 years from three years or so before.
The decision to extend the maturity of the eurozone loan is not surprising since it had been pre-announced in November when Ireland sought financial assistance from the EU.
But the decision to lower the interest rate charged on the loan to Greece by 100 basis points is indeed significant. It will help ease somewhat the burden of servicing the public debt, by proceeding in two ways: First, by lowering the annual interest payments recorded in the budget, therefore facilitating the attainment of the budget deficit goal. Second, by putting the debt-to-GDP ratio in a downward trajectory if nominal GDP growth exceeds the country?s average cost of borrowing, assuming revenues are more than primary expenditures, that is, it runs a primary budget surplus.
The decision on increasing the lending capacity of the EFSF to 440 billion euros along with the authority to buy newly issued bonds by a country with loan programs means Greece could rely on financial assistance from the EFSF in 2012-2013 if it is unable to access bond markets by then.
This is important because it is unlikely that Greece will be able to borrow from private investors at reasonable interest rates by then.
It is reminded that the 110-billion-euro loan from the eurozone and the IMF is about equal to the amount of interest and principal Greece is going to pay to its creditors in the three-year period, running from May 2010 through May 2013.
This has been done by design with the country borrowing more than the money it is paying out to its creditors in 2010 and gradually borrowing less than the total amount of interest plus principal, making it necessary to fill the gap from April 2012 onwards by issuing new bonds to private investors.
Of course, Greece will have to fortify its fiscal framework via legal means and fully complete the 50-billion-euro privatization plan cited in the updated economic policy program (Memorandum.)
The first is possible, but coming up with privatization proceeds of 50 billion euros by 2015 to reduce the public debt, although desirable, seems unrealistic at this point. Assuming the average size of a Greek deal is 100 million euros, the country will have to produce one such deal every three days to meet the goal of 50 billion euros in 1,500 days, as one investment banker put it.
Notwithstanding the strings attached, it has been said that behind the EU?s attractive offer is the realization that the implementation risks of the Greek economic program have increased both on the structural reform front and most importantly on the fiscal front.
The latest figures on the state budget show that the deficit in the first two months of the year was larger than in the same period last year despite the fact that expenditure on the Public Investment Budget was down by more than 65 percent year-on-year. According to an official with good knowledge of the fiscal situation, the deviation of the budget deficit figure from the projected one in the first quarter of the year will be even bigger, making it very difficult to meet the 2011 deficit goal of 7.5 percent of GDP.
In this context, the decisions of the EU Council meeting on March 11 should be welcome, though they largely reflect concerns that the Greek economic program is at risk. Still, they do little to address the thorniest issues, that is, putting the Greek economy back on track and tackling the solvency issue.
However, rekindling economic growth looks like an even greater challenge as the apparent derailing of the fiscal program in the first months of the year will most likely bring about more austerity measures, feeding the vicious cycle. In this regard, some basic tenets of the economic program, namely relying on more taxes to cut the budget deficit, will have to be reexamined.
As far as tackling the solvency issue is concerned, this may be held back by the natural inclination of Greece?s EU partners to put first the interests of the banks and pension funds holding Greek debt and their concerns that the country may contaminate other weak eurozone countries, therefore creating havoc. So, putting pressure on Greece to raise 50 billion euros in privatization proceeds may be the best solution at hand at this point.
All in all, the EU decisions on Greece should be welcomed, but with a pinch of salt because they don?t cope with the country?s two major problems: economic growth and public debt reduction in an effective way.
