Greece may have to play hardball

The negative reaction of the markets to the announcement of the government?s new package of measures spanning the period 2012-2015 makes it almost impossible for the country to borrow some 27 billion euros by selling bonds to international investors in 2012. This means the country will have to prepare for the next phase of the debt crisis and be determined to play hardball.

Hope dies last, we say in Greece, but in this case the country?s fate has been sealed by previous events both under and out of its control.

To start with, the economic policy program agreed with the European Union, the European Central Bank (ECB) and the IMF (International Monetary Fund) in May 2010 failed to grasp the importance of debt reduction in the form of state asset sales and various forms of financial engineering.

This was very important for changing market expectations for a highly indebted country like Greece. By making it a priority early on, it would also have given the traditionally slow moving Greek authorities more time to make the necessary preparations.

Instead, the program was based on the idea the markets will lend Greece the complementary funding of 27 billion euros via bond issuance in 2012 because the credibility of the country would have been restored by adhering to the program, known locally as the memorandum.

But the economic policy program also underestimated the impact of the depth of the recession on tax revenues, projecting initially a double digit increase in tax receipts in 2010 despite the fact that the economy was estimated to shrink by 4 percent or 4.5 percent as it turned out.

The program was rightly front-loaded, aiming at a large reduction of the general government budget deficit in the first few years, especially in 2010, but sought to do so by cutting expenditures and raising tax revenues by almost equal amounts.

The end result was to hurt the healthier private sector, which props up the economy, more, and make the recession deeper, therefore coming up with fewer tax revenues than expected and paving the way for missing the budget deficit target in 2010.

This happened despite the fact the Greece?s primary expenditure has almost doubled between 2004 and 2009, to quote Finance Minister Giorgos Papaconstantinou.

Of course, it is harder for politicians, especially socialists, to try to slash the budget deficit by relying more on spending cuts than tax increases. This is more so in Greece where there is a sort of social contract between politicians and their constituencies, which could be titled ?jobs in the public sector for votes.?

With the party that has excelled by far on this front in power, this type of deficit reduction would have been even more difficult to accomplish unless the troika understood and insisted on spending cuts right from the beginning. Instead, it fell into the trap comfortably used by Greek politicians in the past to avoid tough decisions, namely fighting tax evasion and cutting waste in the public sector to streamline public finances.

But, even if the Greek government did not really live up to the task, the country?s hope of borrowing from the markets early next year or late in 2011 would not have died so early if it were not for a decision made by its EU partners, especially Germany and France.

The decision last fall to set up of the European Stability Mechanism (ESM) did not only help force Ireland to seek a bailout from the IMF and the European Commission and pave the way for Portugal to do so later by hiking its borrowing costs. It also dashed Greece?s hopes of returning to the markets in late 2011 or early 2012.

The concluding statement of the European Council meeting of March 24-25, which addressed the terms under which EU countries may borrow from the ESM, confirmed earlier expectations and led the credit ratings agencies to further downgrade Greece and other countries. It is reminded that under the ESM terms, sovereign debt restructuring is a potential precondition to borrowing from the ESM and senior unsecured government debt will be subordinated to ESM loans.

Since both features were detrimental to private creditors of a country likely to enter ESM, it became almost impossible for Greece to access world bond markets in late 2011 and 2012. It is noted that the country borrows from the markets today by issuing T-bills, which are short-term instruments up to one-year.

Under these circumstances, it was natural for debt restructuring scenarios to resurface recently, boosted also by some disappointing news from Greece: The upward revision of last year?s budget deficit to around 10.5 percent of GDP from some 9.5 percent initially and evidence of much lower revenues and higher spending without counting the public investment budget in the first quarter of this year.

The government tried to counterattack on Friday by unveiling its medium-term 2012-2015 program for fiscal consolidation and privatizations but obviously failed to impress the markets.

Market participants and others think the country will have to agree with its EU partners and the IMF the next step, which most likely will involve some form of debt restructuring. In these negotiations, Greece will have to tell its partners that it is not solely its fault that we reached this point but that they also have to bear some of the blame for its apparent inability to access the markets.

This means Greece may have to play hardball and be prepared for everything. Of course, it is hoped that its partners will understand that it is in everybody?s interest for the country to get out of the debt trap. However, this will not happen unless Greek people are offered a clear choice where there is light at the end of the tunnel.

Asking the Greeks to endure years of economic suffering and then a debt restructuring to enter the ESM for funding is not a welcome choice. In this regard, I think that those who suggest that the government or any negotiator will have to play every card, including the threat of a default if it comes down to that, are right.

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