Making the most of an extension

It looks increasingly likely that Greece?s international creditors will consent to the extension of its fiscal adjustment program, but there is no clear signal yet as to what form that will take. In this context Greece will have to clarify its strategy on the type of extension it seeks with the prime aim of putting the economy back on a path to growth.

A number of EU officials and others have been hesitant in their public statements — to say the least — to embrace the much-talked-about unofficial request of the coalition government and the three political parties backing it. They all have pointed to the Greek side?s inability/unwillingness to deliver on commitments undertaken with the memorandum of understanding on economic and fiscal policies (MEFP) signed in May 2010 and the second MoU on specific policy conditionality.

On the other hand, a few Greek politicians, such as chairman of the socialist PASOK party and former Finance Minister Evangelos Venizelos, have been arguing all along that the extension of the fiscal adjustment effort is obvious because of the deeper-than-projected recession while others, like Prime Minister Antonis Samaras, have brought up pro-growth arguments.

Economic arguments aside, a few lines in the new MoU appear to vindicate this point of view: ?We would consult with the European Commission, European Central Bank and International Monetary Fund in the event of a significantly deeper-than-anticipated recession, to evaluate whether the fiscal adjustment path should be extended beyond 2014.?

With the economy seen shrinking between 6 and 7 percent this year compared to the troika?s earlier revised projection of 4.8 percent and the emerging consensus it will dip further to the tune of 3 percent in 2013 instead of being flat, there is a clear case for extending the fiscal adjustment according to the last MoU.

Pundits say the IMF, which has more experience than the Europeans on these matters, appears to understand and embrace the arguments in favor of extension, in contrast to the EC, which appears to be much more reserved, at least until recently. Of course, the EC officials may be much more reserved because EU countries provide the bulk of the bailout loans to Greece.

Still, the IMF?s willingness to contribute to the funding gap resulting from any extension could have been tested if the Greek government asked for rescheduling the IMF loans equal to 20.9 billion euros falling due up until 2016. Finance Minister Yannis Stournaras did not raise the issue when he met with IMF Managing Director Christine Lagarde last week in Cyprus but perhaps may do so in the future.

Still, Greece has to clarify its strategy beyond simply seeking the vague extension of the fiscal adjustment by two years agreed by the three political parties supporting the coalition government last June. As Dimitris Drakopoulos and Lefteris Farmakis of Nomura correctly point out, the latest austerity measures ?render irrelevant? the main goal of the ?triparty agreement? to extend the adjustment by two years through 2016 ?since this bill respects the 3 percent of GDP deficit target in 2014 (based on March 2012 macroeconomic assumptions).?

Obviously, a two-year extension would be meaningful if the general government budget deficit target fell below 3 percent of GDP in 2016 and not in 2014, as envisaged in the current program, with the primary surplus fine-tuned accordingly. In this context, the latest round of austerity measures worth 13.5 billion euros should be spread out till 2016 or alternatively the country should stick to the current fiscal path and apply the measures in 2015-16. The successful execution of this year?s budget in the first eight months of the year supports this argument.

In this regard, specifying the 13.5-billion-euro measures upfront and having them voted in Parliament does not serve any other purpose but the following: First, it will test the cohesion of the government coalition; second, it underscores the creditors? deep mistrust of the local authorities? ability/willingness to honor Greece?s commitments in the future given their low credibility.

However, the extension can take other forms as well. The creditors may agree to a one-year extension in a bid to minimize the extra funding gap. They may also agree to a two-year extension based on the notion that all restrictive measures will be applied in 2013-14 and any fiscal slippage stemming from the deeper recession during these two years be ?carried over? in 2015-16, meaning no additional measures will be required to correct the deviations from the 2013-14 deficit targets. If this is the case, it will be interesting to see what the government does, assuming the package passes through Parliament, because the bulk of the measures — around 8 billion euros — fall in 2013, rendering any talk of a ?breather? for the economy worthless while fomenting political turbulence.

The coalition government and the three political parties backing it have made public their intention to officially seek a two-year extension of the fiscal adjustment. Still, the coalition government has yet to unveil what version of the two-year extension it wants while pushing ahead with spending cuts and tax revenue enhancing measures worth 13.5 billion euros. In so doing, it raises eyebrows because specifying and voting in all the austerity measures upfront does not look compatible with the meaningful version of the two-year fiscal extension referred to above.

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