ECONOMY

Greece’s large public debt can be beaten

It may appear a Herculean task but past experience shows that Greece can avoid bankruptcy even if its public-debt-to-gross-domestic-product ratio reaches very high levels of about 150 percent of GDP over the next three years. Although there are reasons to think the country will not make it, there are other reasons to believe it can succeed. Despite the popular belief to the opposite, it is not unusual to find countries with a very high public-debt-to-GDP ratio which have succeeded in lowering it without resorting to outright default or some form of debt restructuring. Some of these countries can be found in Europe and more specifically in the European Union. We are referring to countries such as Belgium and Italy. Belgium’s public debt peaked at 141 percent of GDP in 1993 and that is not that far away from where Greece’s is going to peak in 2013, that is, at around 149 percent of GDP from about 115 percent in 2009. Belgium managed to cut its debt-to-GDP ratio by more than 50 percentage points from 1993 through 2007, which amounts to a decrease of about 3 percentage points per year. Italy’s public-debt-to-GDP ratio hit a high at 132 percent in 1998 and followed a downward path, falling by about 20 percentage points between 1998 and 2007 or about 2 percentage points annually. Some argue that the higher inflation in the 1990s helped both countries to boost their nominal GDP which can be broken down into the real GDP and inflation. This is true but the creditors of both countries were compensated in the form of higher nominal interest rates, leading to higher interest payments as a percentage of GDP. Of course, the European economy grew at healthy rates for the better part of the 1990s and interest rates declined as budget deficits were contained and inflation fell. Thorny road Greece may find it more difficult to follow the same path in the years ahead for the following reasons: First, other countries in the eurozone, the EU and elsewhere are adopting fiscal consolidation plans to avert a sovereign bond crisis at the same time. This means that economic growth in the European Union and the eurozone in particular may not be as strong as it was in the previous decades. Even if economic growth was to pick up, the Greek economy is not as open as those of Belgium and Italy to be able to benefit. Secondly, Greece no longer has a national currency to devalue, so it can not pass on some of the burden of adjustment to its trading partners as was the case with Sweden in the early 1990s. This means the cost of the fiscal adjustment will be borne internally in the form of lower wages and layoffs. Thirdly, this country, like Portugal but unlike Ireland and Spain, has a low national savings rate which some estimates put at less than 10 percent of GDP. This means Greece has to rely on large inflows of capital to finance consumption. The big concern is that the private sector will be forced to reduce investment spending if it cannot borrow as the budget deficit is cut, exacerbating the negative impact on economic output and jobs. On the positive side, it looks increasingly likely that the European Central Bank (ECB) will postpone any plans to withdraw the liquidity it pumped into the eurozone via banks to combat the global credit and financial crisis in the last few years. It may even choose to shore up the European bond market by pumping in more money which means euro interest rates will remain at low levels for a greater period than anticipated before. Therefore, we would expect Greece to try to capitalize on this by choosing to take a floating rather than a fixed-rate loan, at least initially, from the 110-billion-euro mechanism set up by the IMF and its EU partners to reduce its interest bill in the coming years. Moreover, Greece’s underground economy could still provide a cushion to the economy’s downside even if it shrinks, as unregistered activity declines due to the recession or comes to the surface. Also, private consumption spending has been declining since the second half of 2009, although jobs and incomes were little affected because households took precautionary measures. This means a part of the expected decline in consumer spending has already taken place and therefore the drop may be significant but not as dramatic as some anticipate. It should be noted that private consumption accounts for more than 70 percent of Greek GDP. We should also point out that inflation is likely to average above 3 percent in 2010 on the back of sizable hikes in various indirect taxes. With real GDP projected to decline by about the same degree, according to Eurostat, it is likely nominal GDP, that is, the denominator in the deficit and public debt-to-GDP calculations, will be broadly stable. This, in turn, will make it easier for Greece to drive the budget deficit-to-GDP ratio close to or lower than the target of 8.1 percent in 2010 from 13.6 percent or more in 2009. Since Greece’s new fiscal plan under the IMF-EU accord calls for a budget deficit of 7.6 percent in 2011, it would have been a big boost to consumer and business sentiment if this year’s budget deficit landed closer to the 2011 target. This shows the damage done to the country’s economy and image by the deadly demonstration on May 5. The subsequent damage to the economy may be more than anticipated due to its negative effect on tourism. Greece has a difficult but not impossible task in front of it. It will take fiscal discipline and financing from abroad of both the state and the private sector along with a revival in private investment spending for it to succeed. History teaches us that the high public debt-to-GDP ratio should not be viewed as an insurmountable obstacle.