Greek debt becoming less sustainable

The agreement between the Greek government and its lenders, which was sanctioned by the Eurogroup last Tuesday, appears to be more of a respite and less of a sea change in the relationship between the two sides. The apparent confidence gap is bound to aggravate economic conditions and undermine talks on debt relief unless it is bridged fast. Refraining from adversarial statements is the least they can do at this point, especially some ministers.

According to the latest revision of gross domestic product data, based on seasonally adjusted figures, the Greek economy shrank by a revised 0.4 percent in the last quarter of 2014 compared to the previous quarter as opposed to a 0.2 percent drop in the flash estimate. This brought the real GDP growth rate to 0.75 percent for the whole year, still better than earlier forecasts, ranging between 0.4 and 0.6 percent. Political uncertainty appears to have taken its toll as households and businesses cut back on spending. Unfortunately, businessmen and others think this trend has continued in the first months of 2015. If they are right, real GDP will dip again in the first quarter of this year, compared to the last one in 2014. This will make it unlikely to reach the budget goal of 2.9 percent annual growth in 2015.

Moreover, international investment banks and others are downgrading this year’s economic growth forecasts, ranging between 0.6 and 2 percent. With the consumer price index continuing to decline, the prospects for an end to deflation do not look promising at this point. In the 12-month period from February 2014 to January 2015, average prices as measured by the CPI decreased by 1.4 percent year-on-year. Even if deflation settles closer to a 1 percent average decline, nominal GDP is likely to be little changed and may even shrink, assuming real economic activity disappoints.

This is not a good omen for the sustainability of the Greek public debt, bankers and others point out. This is even more the case if one thinks the country’s official creditors will accept the government’s arguments and economic reality, lowering the target of the primary budget surplus to 1.5 percent of GDP for 2015. Readers are reminded that the surplus target has been set at 3 percent of GDP in the program for this year and 4.5 percent next year. The country is projected to pay about 6 billion euros, or more than 3 percent of GDP, in interest payments to its creditors in 2015. In other words, interest payments will exceed the likely primary budget surplus, adding to the public debt stock.

The combination of a higher debt stock and a likely flattish nominal GDP will push the debt-to-GDP ratio to higher levels rather than lower as envisaged by the economic program this year. Remember that changes in the nominal GDP figure are the product of changes in the real GDP and average prices. A number of economists will argue this development makes it more difficult for Greece to get the debt ratio down to 124 percent of GDP in 2020, as envisaged in the official Debt Sustainability Analysis. In other words, it calls into question the assumption of the sustainability of the debt. Of course others give more weight to the annual debt service burden instead of the debt-to-GDP ratio. However, this likely development is not good for a heavily indebted country like Greece.

We focused on the sustainability of the public debt instead of the more urgent need facing the Greek state; that is, to cover its borrowing requirement of some 7 billion euros this month for a simple reason: to underline how important it is to build confidence in the relationship between the government and the creditors for the medium term since the damage done so far cannot be repaired in the short run.

We understand it is difficult for the state to honor its obligations to its creditors, its employees and pensioners this month, barring an unforeseen increase in revenues and an influx of money from European institutions – i.e. the EIB, EBRD, structural funds etc. However, we think the state will honor its obligations to creditors in the end even if this leads to an increase in arrears to the private sector and some other actions which will have an adverse impact on economic activity.

Nevertheless, getting over the state funding issue in March will not get the country far unless the Greek authorities start delivering on their commitments and some government officials, such as Finance Minister Yanis Varoufakis, who seems to like to talk to the press a lot, do less talking and more work.

Abstaining from statements which strain the relationship with the creditors is a must and should be a priority. Some of these statements may aim at the domestic audience and may serve internal SYRIZA party purposes, but they do more damage than good. This is more so in view of the negotiations that will take place in the weeks and months ahead for serious matters such as the sustainability of the debt in tandem with the proper magnitude of the primary budget surpluses and structural reforms to make the economy more competitive. The government should stop shooting itself in the foot by allowing some of its cabinet members to engage in verbal warfare with the creditors and undermine much needed trust.

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