Extension could avert more cuts

The Greek government may win back the confidence of its European Union partners if it manages to pass the package of spending cuts amounting to some 13.5 billion euros in Parliament and scores some wins with privatizations. But it may end up losing the confidence of the Greek people if it is unable to come up with a credible timetable for exiting the worst economic crisis to hit the country in half a century and convince them that there is light at the end of the tunnel.

A series of positive statements about Greece by EU government officials and others lately show that the sentiment abroad toward the coalition government?s efforts to put public finances in order and breathe some life into structural reforms is changing for the better.

Assuming the government is able to convince most of the deputies in Parliament to approve the package of spending cuts to keep the country in the eurozone, it is reasonable to expect that its credibility abroad will be enhanced and the troika will grant it an overall positive assessment in its next progress report.

But domestic public discontent is bound to rise further as the new measures will take their toll on households at the same time unemployment continues to march higher, exceeding 24 percent in June.

Austerity fatigue is normal after five years of recession amounting to cumulative output losses of close to 20 percent since 2008, accompanied by the biggest tax hikes in Greek history, pension, salary and fringe benefit cuts, and a sizeable reduction in the minimum wage.

The problem is austerity fatigue has set in while Greece is not even close to achieving the kind of fiscal balance that is compatible with public debt sustainability. The situation is further complicated by the bailout fatigue in creditor countries like Germany, the Netherlands and Finland, which makes it very difficult politically for their governments to seek fresh bailout funds and ease terms for debtor countries.

Greece is required to attain a primary budget surplus of no less than about 2.1 billion euros in 2012 from a deficit of more than 5 billion last year. The primary surplus is targeted to increase to no less than 3.6 billion next year and 9.5 billion in 2014 according to the second Memorandum of Understanding (MoU).

In other words, the country is projected to have more budget revenues than expenditures excluding interest expenses for servicing the public debt in 2012 for the first time since early 2000, making it look better in the eyes of market participants and giving it some leverage over its creditors. So, Greece is still two years away from achieving the primary surplus demanded by its creditors under the current timetable.

But improving budget deficit figures does not mean much to average Greeks. They have seen their purchasing power sapped significantly in the last few years and many of their friends or even themselves join the ranks of the unemployed, and are more interested in knowing when the cycle of never-ending austerity packages will terminate.

This is natural since Greece has taken austerity measures of more than 20 billion euros in 2010 and some 20 billion again in 2011 before getting to the current package of 13.5-14 billion euros. Each time people have been told by government officials that the austerity measures were either the last ones or/and would get the economy out of the woods in a few years? time. According to the projections of the first economic adjustment program, this was supposed to happen in 2013.

So, the coalition government has the tough task of gaining the trust of the average Greek while injecting a new dose of austerity to regain the confidence of the country?s creditors, claiming it will be the ?last such package.?

Some government officials and others think they could ease the pain by coming up with ?offsetting measures,? such as easing the terms on mortgage loans for strained borrowers, and growth initiatives such as restarting the big infrastructure projects and speeding up the absorption of EU funds. In addition, they reckon the release of the next bailout tranche of 31.5 billion euros and the recapitalization of local banks will boost liquidity in the cash-strapped economy. Undoubtedly, all these ?offsetting measures? would help, especially if they are put in place as soon as possible. However, we don?t think they suffice.

To be honest, we don?t think this package of austerity measures leading to net budget savings of around 11.6 billion euros from the expenditure side over the 2013-2014 period will be the last one under the current timetable of the adjustment program. This is so despite the fact that spending cuts are more effective in slashing the budget deficit than tax hikes.

On the other hand, we think it is very likely this package may indeed turn out to be the last one if Greece?s request for a two-year extension of the fiscal adjustment is granted without imposing conditions for additional restrictive measures in 2015-2016. This would provide a breather, improve debt sustainability and significantly reduce the chances of a Greek exit from the euro, instilling confidence in Greek and foreign investors.

All-in-all, the government will have to convince the Greek people that there will be light at the end of the tunnel after taking the new measures, knowing that it will face their mistrust given the previous governments? broken promises. Relying on ?offsetting measures? to prove its goodwill will not be enough. It will have to make its case in a different way.

Pundits who have an idea how key officials and others view the situation could argue that it will be impossible for the government to convince the people that this is the last package and there is light at the end of the tunnel without a meaningful time extension for the fiscal adjustment effort. Time will tell who is right.

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