Private investment spending will hold key to three-year plan

Greece has a good opportunity to prove Euroskeptics wrong after agreeing to a new package of austerity measures worth about 30 billion euros in savings over the 2010-2013 period to obtain access to more than 100 billion euros in funds from the European Union and the International Monetary Fund (IMF). The heavily indebted country had no option, after a series of economic and debt management policy mistakes over the last six months or so by the new government and complacency on the part of the previous government brought the situation to the point where markets questioned the sustainability of its fiscal position. As one senior local banker put it, «beggars can’t be choosers» and Greece had to give in to the demands of its partners and the IMF to secure official funding of some 110 billion euros in order to continue paying wages and pensions in an overblown public sector. The combination of hefty pay cuts for public sector employees and pensioners of both the public and private sectors could most likely have been avoided. At least this may have been possible if Greece had acted decisively early on – that is, in the last quarter of 2009 and perhaps early this year – and surprised markets by slashing the 2010 budget deficit by relying more on spending cuts and less so on tax hikes. By not following the example of Ireland, which had also found itself in the eye of the storm, it was inevitable that what followed would be more difficult and require skillful public debt management to ease market concerns about Greece’s refinancing risk in April-May when T-bills and bonds in excess of 20 billion euros matured. By believing in the power of the EU aid mechanism to bring down Greek spreads, the government and the country made a serious miscalculation. It is the kind of miscalculation Greece had avoided in the first quarter of 2009, when then Finance Minister Yiannis Papathanassiou had reportedly found himself under pressure from high-level EU and ECB officials for Greece to accept the creation of a similar aid mechanism. But Papathanassiou reportedly balked at the suggestion, probably sensing that such a development would have made Greece the center of attention in international markets, insisting that the country will have no problem raising the necessary funds at market interest rates. And it did, raising more than 60 billion euros and having to refund some 10 billion euros more for bond redemptions than in 2010. Of course, this is all history now, but very enlightening for any government. Still, Greece will have to go the distance and put its public finances in order because the alternatives, basically any form of debt restructuring, will be devastating for the country and perilous for the euro project. Fiscal adjustment is indeed very demanding for a country which has no national currency to depreciate, for it must assume part of the internal fiscal burden even though it has a low rate of gross national savings, equal to about 5 percent of GDP, which in turn means it will have to rely on large inflows of capital to fund its consumption. There are many out there who have made the calculations and concluded the country will not make it. These are not just Euroskeptics who see in Greece the weak link in the most ambitious financial project in history, but others, who simply look at numbers. Greece will have to run a primary budget surplus as a percentage of GDP equal to the difference between its higher average cost of borrowing and nominal GDP growth to stabilize its debt-to-GDP ratio, seen close to 120 percent of GDP in 2009. This would be quite an achievement for a country running a primary deficit of more than 8 percent of GDP in 2009. It is worth noting that a primary budget does not include interest payments on public debt. But although this is difficult, it is not impossible if the Greek economy is able to recover relatively fast after recording an estimated decline of 3 to 4 percent in 2010. Since consumption is likely to continue to be weak as unemployment rises and disposable income is hit, the ball will be passed to the external sector and more importantly, investment spending. Since public investment spending is to be cut further to help facilitate the sizeable fiscal adjustment, the focus should be on private investment spending, both domestic and foreign, since it may well be the latter component which may decide Greece’s future. However, the odds will not look good as long as the state comes up with new taxes to prove its fairness in a country with more than 13,000 public entities. Still, Greece and its notorious underground economy can rise to the occasion and suprise everybody if the execution of the fiscal program is relatively good and reason prevails over sentiment among the vast majority of the people.

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