Negotiations between Greece and its lenders finally got off to a start last week, but their outcome is uncertain although both sides have vowed to do their best to clinch a deal by the end of April. The road ahead will be rocky as the government seeks a compromise in the context of a political solution with some technocratic backing. However, the deterioration in underlying economic conditions could make even this compromise difficult to reach unless the lenders and Germany in particular are willing to make concessions.
This year could in fact have been a good one for the Greek economy if it were not for the uncertainty emanating first from politics and second the negotiations with the lenders. After six years of GDP contraction, the economy grew by 0.8 percent last year and was coming into 2015 with some momentum. The drop in world oil prices was going to help by beefing up the purchasing power of households and lowering the operating costs of many businesses. Moreover, the weaker euro was bound to help the export of goods and services to countries outside the eurozone. Under normal circumstances, Greece would have reached a deal with the troika, clearing the way for participation in the European Central Bank’s bond-buying program (QE).
Things look quite different right now. The country is still profiting from the lower oil prices but export-financing hurdles are limiting the benefits from the weaker euro. Greece is not entitled to take part in the ECB’s QE program and is struggling to repay loans to the International Monetary Fund and other creditors as well as pay pensions and wages. In addition, it looks as if individuals and businesses are increasingly trying to hold on to cash while banks are less willing to provide fresh loans, dashing hopes of a return to credit expansion in the first half of the year. In other words, credit conditions are getting tighter and this will hit economic activity sooner or later.
The likely gross domestic product slowdown will impact on public finances, undermining revenues. If other things hold constant, the primary budget balance will likely be worse than envisaged. If the European Union, the IMF and the ECB insist on the same primary budget surplus target for 2015, set at 3 percent of GDP in the program, the fiscal gap will be large. In this case, billions of euros in extra austerity measures will be required, bringing the new SYRIZA-Independent Greeks government to a difficult position.
Government spokesman Gavriil Sakellaridis said on Friday that a referendum may be called for people to decide if new austerity measures are demanded by the lenders. Putting aside the pros and cons of a referendum, it is clearly one thing to be called upon to vote for tax hikes and pay cuts of, let’s say, 1 billion euros, while it is quite another to vote for similar measures of 3 or 4 billion euros. But the size of the fiscal gap, the difference between the actual outcome and the target, will also be determined by the target. There are already signs the lenders are willing to soften their stance on this matter and accept Finance Minister Yanis Varoufakis’s call for a 1.5 percent of GDP target. If accepted, it will be a significant concession on the part of the creditors and Germany in particular.
Of course, it will contrast with the troika’s demand in fall 2014 of the previous government that the 3 percent of GDP primary surplus target be met. It is inevitable that such a gesture will have political implications as well. It will send a message of hope to the anti-austerity forces abroad and vindicate hard-line Greek conservatives who favored a confrontation with the troika to obtain concessions and limit political damage at home. Geopolitical considerations about Greece’s position and role in the greater area and the political will not to allow a “Grexit” may weigh more now, leading to a softer stance by Germany and others. After all, there is a small amount of additional loans required now, as some international bankers have pointed out.
There is no doubt this government is a different animal than the ones Germany and the other lenders are used to dealing with. It is clear the new administration favors a political solution and does not see the usual procedure used by the so-called institutions to evaluate progress in a positive light. For political reasons, it wants the representatives of the lenders to have minimum contact with the ministries etc. This points to weeks and perhaps months of negotiations between the government and the lenders. The Greek side is preparing for it by making sure the state has enough cash to honor the inelastic expenditures during this period. Making use of state entities’ cash reserves and the 100-installment scheme to pay tax arrears seems to be part of the plan. Still, the protracted negotiations will not do the economy any good and will magnify problems.
The apparent deficit of trust between the Greek government and the lenders, which is obvious in the war of words, is not a good omen. This does not mean both sides cannot reach a deal even if it takes quite some time as Greece seems to have found adequate funding for the foreseeable future. Still, it looks as if it will likely require a concession on the part of the lenders on the fiscal target for 2015, close to the one proposed by Varoufakis.