Government will have to meet its borrowing needs from big players

Greece’s inability to put its public finances in order has essentially made it the guinea pig of the eurozone for policy action in the case of extreme credit events. It is up to Prime Minister George Papandreou to convince the capital markets of his determination to put government finances on a sustainable path rather than leave it to the EU to bail out the country. It will take deeds and not just words to make this happen. From the point of view of the EU authorities, the instances of Greece and Ireland should be viewed as case studies. Especially Greece’s. What do you do to protect your credibility and that of the euro when the budget deficit of member states soars along with the public debt and moreover runs the risk of having some bigger member countries on the same slippery fiscal path? Obviously, you want to help them get out of their mess but without signaling to others that you are soft, which may encourage similar behavior. Greece’s new socialist government could make it easier for the EU and the ECB, just as Ireland has done so far. The new administration admittedly undertook a tough task when it assumed power on October 4. The economy had slipped into recession for the first time since 1993 and the budget deficit widened further because of extraordinary spending related to the twin elections for the European parliament in June and early general elections in October and the ensuing relaxation in the country’s tax collection mechanism. However, it made things worse by letting the budget deficit rise to an estimated 12.7 percent of GDP, although it could have kept it in single figures according to both pro-government and conservative opposition critics as well as independent economists. The latter charge that the government underestimated the markets’ reaction and let the deficit balloon by choosing to boost tax refunds to exporters and farmers worth some 5 billion euros in the 2009 budget, compared to 3.7 billion estimated in the budget submitted by the conservatives and 2 billion euros in 2008. It also failed to mobilize the state’s tax collection mechanism to collect real estate taxes from 2008 and 2009 this year, instead postponing their collection until 2010 and did not seek to collect billions from the EU relating to the Public Investment Program. The same economists say the markets and perhaps the European Commission would have reacted in a more positive way if the 2009 budget deficit had been kept below 10 percent of GDP since it would be easier to reduce it to 3 percent of GDP in a shorter period of time. But this is history. The new government is under pressure from the markets and the EU to correct the country’s fiscal imbalances and is being compared to a high benchmark, namely Ireland, whose tolerance for pain likely exceeds the pain threshold of Greek society. The Irish example of reducing the budget deficit by relying heavily on cutting primary spending has many supporters in the EU and the markets but it looks as if it has few in the Greek socialist government. The unveiled 2010 Greek budget aims to cut the deficit to 9.1 percent of GDP from a projected 12.7 percent this year by relying much more on tax revenues than spending cuts, once one takes out the non-recurring budget expenditures of about 2.5 billion euros in 2009. Of course, the government has made it clear that it wants to combine the necessary fiscal adjustment with a fairer redistribution of income in Greek society and prop up the economy as much as possible by increasing public investment spending. This is consistent with its election promises but apparently has disappointed the markets, which are eager to pay less attention to the 10 percent or more loss of Irish economic output since the global financial crisis hit and more to deep spending cuts in the public sector. So, they may not like it if Papandreou decides to stick to the old plan of raising revenues to narrow the budget gap in 2010 and beyond instead of following Ireland’s example. The consequences may not be significant if the Greek government manages to find a few big buyers for its new borrowing in 2010, seen totaling some 55 billion euros from an estimated 66-67 billion this year. With the Greek banks being rather minor buyers of Greek debt this time around, it has got to be somebody else. Perhaps, Chinese credit institutions. If, on the other hand, the government disappoints the markets and has not lined up a few big buyers for its new debt issues, it is likely Greek assets will come under renewed pressure, prompting the government either to beef up the set of austerity and structural measures to satisfy the markets or leave it to the EU to do the job. It is certain that no one, neither the Greek government nor the EU and the ECB, would like the situation to come to that point and it does not have to, since the stakes for both sides are high. Perhaps more so for the EU authorities who want to safeguard the credibility of the euro project as well as their own.

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