How to make an already terrible financial situation even worse

If there were a Nobel Prize for economic crisis mismanagement, Greece would be nominated and perhaps would deserve to win it. As the country braces itself for a new set of austerity measures seen as pushing the economy into a deeper recession, many wonder why all this had to happen and what we can expect from now on. Greek businessmen and bankers are fully aware of the economy’s chronic problems which the global crisis helped bring to the surface as well as its overall bad shape. But they are also furious, irrespective of political stripes, about a series of policy mistakes that have made the situation worse and practically brought the country to its knees. In speaking to hedge fund managers who have sold off Greek bonds and stocks over the last few months, as well as local analysts and others, a consensus seems to be emerging as to what went wrong. The new PASOK government, which inherited a huge problem upon its election on October 4, failed to grasp early on the severity of the situation and the destructive potential it could unleash, that is, during November-December 2009. Whether this was due to a split between the populists and the pragmatists in the ruling party over the right policies and/or a poor estimation of the consequences of its actions should the government adopt a softer line on fiscal consolidation is not clear. However, all agree that the government missed a great opportunity last December to turn market attention away from Greece by making an impression with an unusually sharp reduction in the 2010 budget deficit. The gradual approach of aiming first for a budget deficit equal to 9.2 percent of gross domestic product (GDP), which was to have been lowered to 8.7 percent of GDP in the 2010-2013 Stability and Growth Plan did exactly the opposite. Even now it is difficult to understand why this happened, despite the political considerations and the new government’s social sensitivities. Government officials knew very well that one of the four percentage point GDP reductions in the 2010 budget deficit was due to one-off and exceptional measures. It was therefore apparent that the EU and the markets would easily identify it and ask that it be corrected via additional measures at some point later on. If Greece had gone for a five-percentage point reduction in the 2010 budget deficit to 7.7 percent of GDP last December, it would have impressed the markets. It would have perhaps gained the benefit of the doubt from the EU as well, since the deficit reduction effort would have been appreciated much more. By going for the four-percentage point of GDP budget deficit cut, Greece trapped itself because the markets kept the pressure on, worsening the spillover effects on the banking and private sectors. Even in early February, when Prime Minister George Papandreou announced a set of austerity measures equivalent to 0.5 percentage points of GDP, nobody was impressed. The additional measures were not enough to make up the one percentage point reduction from the nonrepetitive measures in the 2010 budget. Moreover, market pressure helped further dent business and consumer sentiment, deepening the recession, which, in turn, required even more measures to bring the deficit down to 8.7 percent of GDP. By all accounts, the government is going to announce a new fiscal package of tax hikes and spending cuts amounting to 2.0 percentage points of GDP or 4.8 billion euros. This is one percentage point of GDP more than it would most likely have to go had it opted to cut the 2010 budget deficit to 7.7 percent of GDP last December. The question now is whether the new package will suffice, or if the country will have to take measures in a few months again. Assuming the size of the fiscal package is equal to or greater than 3.6 billion euros or 1.5 percentage point of GDP, it is difficult to see how EU Monetary Affairs Commissioner Olli Rehn, visiting Athens today to meet with Premier Papandreou, Finance Minister Giorgos Papaconstantinou and others, would not give his blessing. However, the markets will not likely show the same generosity. Even if the EU and the European Central Bank endorse the new package, the markets will most likely keep the pressure on and not let the premium, paid by Greece to borrow over Germany, come down significantly. Greece will have to raise another 20 billion euros or so on international markets to remove the liquidity risk and also provide convincing evidence that it is sticking to its fiscal plan in the next months, and perhaps quarters, to see any actual de-escalation in its borrowing. But it has nobody to blame but itself. Its starting point was not good but crisis mismanagement made it worse.

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