In a bid to give some breathing space to the economy and send a political message, the coalition government appears ready to set a fiscal target in the 2015 budget lower than that specified in the economic adjustment program. This would be the first time since the coalition government took over in the summer of 2012 that it took such a step. If objections to the new fiscal goal are based on concerns about the reaction of the markets, as one EU official has indicated, they should be withdrawn. The markets are much more eager to see the Greek economy growing than to see a primary budget surplus next year that is higher than in 2014 but lower than the one targeted.
Trailing in the polls and feeling the pressure from the leftist SYRIZA opposition, and with a growing number of people running out of patience after a six-year slump, the government is trying to walk a tightrope between complying with the demands of the adjustment program on one hand and coping with domestic political, social and economic reality on the other. In this regard, it has apparently decided to set a target for the primary budget surplus lower than the 3 percent of GDP set out in the program. It could be set at 2.3 percent of GDP from a 1.5 percent target this year and a better-than-planned 0.8 percent in 2013 if press reports are correct. Based on the January-August budget figures, this year’s primary surplus target looks likely to be met.
By setting a lower target, the government wants to accommodate some tax cuts and honor court decisions returning hundreds of millions of euros to judges and military and security forces, to help stimulate the economy. Moreover, it hopes to avoid taking new measures to fill the fiscal gap between the estimated budget outcome and the primary surplus of 3 percent next year. It is reminded that Greece has taken unprecedented austerity measures, amounting to 30 percent of GDP since 2010. This way fiscal policy will not be a drag on growth, helping the economy recover from its multi-year slump and giving some hope to citizens hit hard by the unprecedented austerity.
Some may object to this move, arguing a smaller-than-planned excess of revenues over primary spending, which excludes interest payments, which could undermine the debt reduction process and the sustainability of public debt. This is a valid argument if the primary budget surplus is the main vehicle to debt reduction. However, one should not underestimate the effect of the budget on growth and vice versa, as well as debt dynamics.
Since the 1970s, the large reductions in public debt ratios have relied much more on favorable interest rate and growth differentials than fiscal consolidation. Greece enjoys low borrowing rates on the official loans from the EU, EFSF and to a lesser extent from the IMF, but its economy has shrunk for nearly six years. A past OECD study estimated Greece would have to run a primary budget surplus of about 9 percent of GDP from 2014 to 2023, Italy and Portugal about 6 percent, while Ireland and Spain about 3.5 percent of GDP to stay within the eurozone debt convergence rules. The latter prescribe a 60 percent gross government debt-to-GDP ratio with a portion of the excess over that level being removed each year.
If fiscal consolidation was the way back to the Maastricht Treaty’s 60 percent general government debt ratio, the indebted countries would have had to endure a long period of high debt ratios and high primary budget surpluses. There is no doubt this would have hurt their growth prospects and possibly undermine political stability and social cohesion.
We have argued in the past that Greece is a relatively closed economy that requires time to become more export-oriented, meaning the budget will continue to have a bigger effect on the economy than it would have been the case otherwise. Running primary budget surpluses to the tune of 4 percent of GDP from 2016 on will hurt both growth and debt dynamics. This is more so since the country cannot devalue its currency to stimulate growth, making structural reforms the only way forward. However, fatigue has set in as vested interests oppose reforms and a protracted recession has provided no fertile ground.
Others, like an EU official in Brussels cited by the press recently, argue against a lower primary budget surplus because it will send the wrong message to the markets and others. While it is another valid point, it does not take into account the fact that the markets are more concerned about Greek growth prospects than setting the primary surplus at 2.3 or 2.5 percent instead of 3 percent of GDP in 2015.
The markets are betting that the Greek economy will grow and believe these prospects will be dimmed if the government is forced to take new austerity measures to meet the 3 percent of GDP target. In other words, disappointing growth expectations is a bigger risk than setting a lower primary surplus. We think the markets are smart enough to comprehend the risks of the Greek trade in the context of the ECB policy, a more pro-growth approach at the eurozone level, the composition of the Greek debt and their own need for a yield pick-up.
All-in-all, setting a modestly lower primary budget surplus for 2015, perhaps at 2.5 percent of GDP, will help the prospects of economic recovery. This is more so if future debt relief talks lead to a lower primary surplus target. This could be more market-friendly than sticking to a high fiscal target that may undermine recovery.