The government says it will not yield to the troika’s demands for a projected fiscal gap in 2015 to be addressed with more austerity measures. Regardless of the outcome, Greece is likely to be forced to ask for an extension of the current bailout program, perhaps for a few months, a prospect that would be politically detrimental to the coalition government. Although some in the government consider the IMF’s tough stance on the fiscal gap largely responsible for the impasse, the real source of the problem may lie elsewhere: In German Finance Minister Wolfgang Schaeuble’s insistence that the IMF stays in the Greek program, and in the government’s mishandling of the issue earlier.
Negotiations between the coalition government and the troika over filling a disputed fiscal gap next year – that is, the difference between the projected primary budget surplus and the program target for a surplus equal to 3 percent of GDP next year – stalled once again last month. This made it impossible to reach a technical agreement on the final review of the adjustment program before Monday’s Eurogroup meeting, paving the way for an extension of the bailout program, which expires at the end of 2014.
The Greek side sent its answer to the troika’s remarks over the disputed fiscal gap, including new arguments, i.e. tax buoyancy, backed by additional data. Finance Minister Gikas Hardouvelis’s suggestions that the troika was wrong in its predictions about the fiscal gap in the last two years annoyed the lenders and did not help the negotiations, despite the fact that he was right. But it is also true that the administration’s current proposals to bridge the gap are guided more by political considerations than economic rationale. For example, its unwillingness to do away with the 30 percent reduction in VAT tax rates enjoyed by certain wealthy islands like Myconos, Santorini, Paros and others.
At the center of the discussion about the disputed fiscal gap lies the important issue of the sustainability of Greek debt. The influential German finance minister and even ECB President Mario Draghi have stated that the Greek debt is sustainable. The deputy prime minister of the coalition government, Evangelos Venizelos, has also made a statement to that extent. The issue is not simple. If one believes the economy can grow at the high rates predicted in the latest debt sustainability analysis (DSA), have low borrowing costs and produce large primary surpluses to the tune of 4-4.5 percent of GDP for many years from 2016 on, then the Greek debt should be deemed sustainable. In this case, there is no need for additional debt relief, including a haircut on the nominal value of the debt.
In other words, the public debt will account for less than 110 percent of GDP in 2022 according to the projections. This means the Greek debt-to-GDP ratio will likely be lower than the Italian debt ratio. Moreover, the Greek debt will have a much better maturity profile than that of Italy and other eurozone countries with a high debt ratio at the time.
On the other hand, if somebody believes Greece cannot deliver such large primary surpluses for such a long period of time, the picture changes completely and the public debt becomes unsustainable. We, like others, believe the second camp is right. Of course it remains to be seen.
So, we are in a complicated situation. The German side does not want to move the goalposts and lower the targeted primary target because it will make the debt unsustainable. Furthermore, it does not want to take debt relief measures for political and other reasons. On its part, the IMF recognizes that the Greek debt is not sustainable, which explains why it was advocating a haircut in the past, unless the country runs large primary surpluses. So, it wants to make sure next year’s primary surplus target is met and is putting pressure toward that end, prompting reactions from Hardouvelis and others in the government. But the IMF is simply doing its job and seems to be less willing to turn a blind eye like it did in past reviews. Therefore, it seems to us, the IMF wants to send a message to Schaeuble rather that the Greek government. Moreover, strange as it may be, both Schaeuble and the Greek government, albeit in different ways and with different objectives in mind, have kept the IMF in the Greek program.
Contrary to conventional wisdom, we are not fully convinced that the IMF did not want out after receiving some guarantees from the EU. The remaining IMF loans to Greece amount to about 16 billion euros and we are sure the Fund would have preferred not to disburse them. It is likely Schaeuble wanted the IMF to stay in order to help convince skeptical German lawmakers to vote along when Greece-related bills came to parliament. Also, the Greek government wanted the IMF out for domestic political reasons but shot itself in the foot by communicating it in a way that irritated IMF officials and stirred market concerns.
So, the stalemate over the 2015 fiscal gap, which we expect to be resolved somehow before or at the EU summit later in December, is more complicated than Greece disagreeing with its lenders. Schaeuble has said the Greek PSI, which entailed a large haircut on Greek debt, will not be repeated, implying it was a mistake. Some argue the direct involvement of the IMF in the Greek program was the second mistake and sooner or later the EU will be called to deliver what the IMF is implicitly asking for by sticking to its guns on the fiscal gap issue.