A fair compromise is the way forward

Greece has been caught in the vicious cycle of austerity, deep and protracted recession, and a rising debt ratio in the last few years. It is likely to be remain so for another year if creditors insist on another strong dose of fiscal austerity to fill the 2014 fiscal gap that has been projected by them. The political and economic repercussions of such a move in an election year should not be underestimated. Therefore, a compromise that makes economic sense should be reached.

Athens agreed last year to take frontloaded austerity measures to record a small primary surplus this year and a bigger one, equal to 1.5 percent of GDP in 2014 en route to 4.5 percent in 2016. This was part of the deal to extend the fiscal adjustment by two years to 2016 and came on top of more tax hikes and spending cuts implemented since 2010, exceeding cumulatively 30 percent of GDP.

For the second year in a row, the country seems on course to meet the budget target. International lenders agree revenues will exceed expenditures excluding interest by about 340 million in 2013 although government officials put the figure significantly higher. Last time Greece posted a primary surplus was back in 2002. But the representatives of the lenders are demanding that Greece takes even more permanent austerity measures in 2014 to ensure the primary budget surplus goal of 1.5 percent of GDP. EU officials estimate that austerity measures of up to 2 billion euros should be taken to meet the fiscal target, whereas the government puts the figure at 500 million euros maximum.

The difference in the two estimates is quite large and has to be resolved. Perhaps it would have been easier if the elections for European Parliament were not held in 2014 and political priorities in Greece and Germany were not different. From the Greek government’s point of view, going into elections next year after adopting a new set of austerity measures and without having to show something in return, like debt relief measures, amounts to near political suicide. Extremist parties, most notably far-right Golden Dawn, stand to benefit according to some officials. This is more so since additional measures to the tune of 2 billion euros will undermine the projected anemic growth of 0.6 percent. On the other hand, it is understood that German Chancellor Angela Merkel would like to avoid granting Greece such debt relief measures, even if the country had met all the preconditions, prior to the elections for European Parliament next May, as this would play into the hands of the euroskeptic AfD party.

Going back to economics, we are facing the same fiscal problem once again. Greece is being asked to take additional measures to fill a fiscal gap created to a large extent by cyclical forces, namely the GDP contraction of over 22 percent since 2008. The EU estimates that the primary balance would have been in surplus, exceeding 6 percent of GDP, in 2013 and 2014 if the economy operated at full capacity, probably growing at 2.5 percent per annum. But this opinion, endorsed in the Fiscal Compact, is not shared by the country’s creditors. The extra funding required in the absence of measures perhaps explains their unwillingness to go along.

Nevertheless, Greece has no option but to work with its lenders to identify measures to close the fiscal gap and meet the primary surplus goal of 1.5 percent of GDP next year without inflicting too much damage to the economy. Despite the different estimates of the two sides, we think creditors should give Athens the benefit of the doubt and accept that measures filling half of the agreed upon fiscal gap be included in the budget.

For its part, Greece will accept to take more measures if there is a discrepancy between the actual budget outcome and the target after June in the form of a supplementary budget, coinciding with the Eurogroup’s debt relief measures. This is a fair compromise that goes some way toward avoiding another major policy mistake that may inflict unnecessary economic pain and have unforeseen political consequences.

Regarding the 2014 budget, lenders are not being unjust in their demand that the new wage structure in the public sector be implemented across the board immediately, with no exceptions like uniformed officers. It is reminded that the government decided to postpone the inclusion of the police, coast guard and armed forces in the new wage structure, depriving the 2014 budget of savings of 250 million euros or more. The immediate implementation of the wage structure along with tighter rules for overtime work in the public sector next year could save some 300-400 million euros.

Moreover, the troika should ask Greece to close remaining loopholes favoring special interest groups. This along with structural measures aimed at savings of 500 million euros from social security funds – though it looks like they may be 100 million euros short at least – can produce total budget savings of 700-800 million euros. The government and its creditors should also agree that 70 percent of any amount exceeding this year’s primary surplus target be counted toward meeting the primary budget goal and not be distributed next year. This will take some pressure off the economy while ensuring the fiscal target.

All in all, Greece and the lenders can work out a fair compromise that makes economic sense. This should give the government some breathing room in the first half of 2014 in exchange for more measures, if warranted, in the second half when the EU will be ready to announce debt relief measures. This way Greece will be able to adopt structural measures and implement the new wage structure across the public sector to produce more savings without exerting too much pressure on the economy.