If things turn out as expected, Greece is likely to secure another rescue loan package from its eurozone partners and the International Monetary Fund, covering its borrowing needs until mid-2014.
However, even this deal may prove inadequate to appease markets and return the country to a growth trajectory if the government does not deliver on promised structural changes, the European Union does not help in fostering growth, and credit supply to the private sector does not gradually resume. The latter requires a major change in the banks? current model.
Some may say the economic policy program agreed with the European Commission, the European Central Bank and the IMF on May 3, 2010, has largely attained its goals but others will disagree. As we have made it repeatedly clear, we side with the latter.
In addition to failing to convince the markets about Greece?s solvency, which necessitates an additional rescue loan to keep it afloat, the program did not even come close to meeting last year?s budget deficit reduction target even if one did not take into account the inclusion of loss-making corporations in the broader public sector. This is despite taking an unprecedented amount of more than 23 billion euros in austerity measures in 2010.
It is obvious a hyperbolic dose of austerity, mainly in the form of tax-generating measures, has hit both the private sector and the economy without producing the planned drop in the budget deficit. Moreover, the outcome from the execution of the state budget in the first four months of the year is not promising either.
So, it is of utmost importance that the Greek economy stabilizes and starts growing again while the privatization program is implemented to convince markets it is not going to default in the future.
Some domestic reforms envisaged by the program to make the tradable sector more productive by slashing salaries and lowering living standards will turn out not be enough to boost the economy for various reasons.
First, Greece?s goods export sector is relatively small and tourism will not help as much as some think, judging by the all-inclusive packages offered.
Second, they will not remove lingering uncertainty about the fate of the country and the banking sector which has helped withhold private investments.
We argued last week that the EU could do a great service to the country by turning its attention to mobilizing structural and other funds to help the Greek economy exit the current vicious cycle of austerity hurting the economy and in turn requiring more measures to meet the deficit goal while the debt-to-GDP climbs even higher. Front-loading the spending of structural funds is important to this effect.
However, it is also very important for fostering growth that supply to the private sector is being restored. It is true that countries that needed to pay back their public debt in the past went through a period of deleveraging. According to bankers, loans fell by 30 to 50 percent from their peak in similar episodes in the past and Greece cannot be an exemption.
However, if this turns out to be the case here, the recession will be more protracted and deeper than many analysts think. It is therefore important that this does not happen and this requires a well-capitalized and liquid domestic banking sector.
It is known that local banks did not create Greece?s debt problem. However, they are part of the problem now. So they will have to take initiatives to address their three main weaknesses as soon as possible to be able to play their intermediary role and provide credit to the private sector since the public sector will be funded by the new rescue package, assuming everything goes well.
The three main issues confronting Greek banks are their significant exposure to the state, mainly via government bonds, the rising nonperforming loans and their high operational costs at home.
One drastic solution would have been for local banks to recognize all their losses related to state bonds and loans and recapitalize. Given perceptions about the situation in Greece, it is more likely very little capital could have been found and therefore the banks would have been nationalized, ending up in the Financial Stabilization Fund endowed with 10 billion euros under the initial 110-billion-euro rescue loan.
Another solution would have been to wait it out, hoping the Greek economy will improve and the state will regain the confidence of bond markets in the next few years. At this point, this seems to be their strategy. This may be combined with some large deals aiming at extracting gains via synergies.
Whatever happens with their exposure to Greek bonds, local banks will have to understand the environment requires that they change their retail banking model. This means they will have to proceed sooner or later with substantial cuts in operating expenses and the more they delay the deeper they will have to be to survive.
By doing so, they will be ready to instill market and depositors confidence in them.
Of course, this will not be easy but the sooner they do it, the faster the deleveraging will end, making it possible to gradually resume providing credit to the Greek economy and the cash-starved private sector.
It is therefore important for the Greek economy to stabilize and grow that local banks change their retail banking model to conform to the new economic landscape by reducing sharply their operating expenses regardless of how they treat their bond holdings.
This is likely to constrain the period of deleveraging and open the way for slowly funding the private sector, contributing to the rebound of the economy.