Government must stop kicking the can down the road
Greece?s economic fate lies in the ability of the government to overhaul the large, unproductive public sector and help the private sector recover. Whether this is possible remains to be seen but the political developments in the last few days make one think twice whether this huge task can be carried out, but it is encouraging that some European leaders finally seem to understand how high the stakes are.
Prime Minister George Papandreou decided last week to reshuffle the Cabinet, appointing Evangelos Venizelos, his main party rival, as finance minister and requesting a vote of confidence from Parliament, which he is likely to get on Tuesday.
He may also see the medium-term strategy plan approved by Parliament in the next couple of weeks, securing the fifth installment of 12 billion euros from the European Union and International Monetary Fund package, and perhaps see the EU leaders approve a second aid package next month to calm the markets.
Undoubtedly, the chaotic political situation in Greece last week and the negative reaction of the markets made more EU leaders realize how big the stakes are since it made clear the extended damage the contagion from any disorderly default would have caused to eurozone, other industrialized economies, many emerging markets and the international financial system.
So it comes as no surprise that Germany dropped calls for a mandatory bond exchange that would most likely lead credit rating agencies to declare Greece in default, opening the way for a second aid package.
It should be noted, however, that press reports putting the new financial package at 100 billion euros or more are partly misleading. This is because the initial rescue package is 110 billion euros and Greece will have another 45 billion euros to get assuming the next tranche of 12 billion euros is fully disbursed in July.
Greece?s borrowing needs are estimated at between 137 and 140 billion euros until mid-2014 so the country will need an additional amount of 92 to 95 billion euros to fully cover its estimated needs by then.
According to available information, private sector participation in the form of a voluntary rollover of debt could be between 25 and 35 billion euros over this period. In addition, Greece will commit some 30 billion euros from privatization proceeds and the development of public property. The total from these two sources is estimated at between 55 and 65 billion euros. This leaves some 40 to 37 billion euros for the EU and the IMF to fill in which is not really such a big amount assuming the country sticks to its promises.
In other words, the second aid package is not in reality as big as one assumes when one hears about 100 to 140 billion euros for the reasons we explained above.
To put it in contrast one has to consider the cost of not bailing out Greece and other peripheral countries if necessary. According to some calculations by Credit Suisse, the cost of bailing out peripheral eurozone amounts to about 200 billion euros needed to bring the public debt-to-GDP ratio down to 100 percent.
This compares favorably with the direct cost of leaving them on their own which is estimated at some 500 billion euros or more. The calculation is based on the assumption that core Europe holds 800 billion euros of assets in peripheral Europe and there will be haircut of 50 percent. It also takes into account the European Central Bank?s government bond holdings of 75 billion euros and a portion of the ECB?s repo-ing of peripheral debt.
However, this should not distract anybody?s attention from the need for Greece to tackle the root of its problem which is the public sector. It is really strange for a country facing such a grave debt crisis to spend half of its output in preserving such a huge public sector. It is noted that general government spending amounts to about 50 percent of GDP in Greece.
So it is not really surprising that many analysts and bankers think Greece could really strike a chord with the markets if it had a government determined to produce spending cuts equal to 10 billion euros accompanied by selective tax cuts to encourage investments by the private sector this year.
This cold-turkey approach could have caused more pain in the short term but could have helped the economy recover faster, especially if it was accompanied by opening up tens of professions to competition by lifting barriers to entry and selective privatizations.
Of course this requires doing away with unnecessary public sector entities and significant cuts in the payroll of the public sector which the current government and perhaps the other mainstream political parties are clearly unwilling to do.
However, economists who have experience from other sovereign debt crises in the past say the lesser-pain approach taken today by Greece prolongs the recession, making austerity programs less socially and politically acceptable in the end.
Moreover, this gradual approach which amounts to kicking the can down the road as long as the country does not implement the necessary structural reforms may end up in a sudden death when the financial backers pull out.
Undoubtedly, Greece missed an opportunity last week to form a national unity government and pursue more aggressively a reform agenda at the same time it sought greater aid from the EU in the form of structural funds and loans and changed the composition of its fiscal policy in favor of spending cuts to meet the budget deficit targets.
The new government can do better than its predecessor in economic policy formulation and execution but it unfortunately looks weaker from a political point of view and this is not an encouraging sign.
