An imperfect balance

A lot of time has been devoted to words over the past few days in Athens and other European capitals. Perhaps spending some time considering a few numbers might prevent Greece and its European partners soon having nothing left to say to each other.

Even the most faithful party apparatchik, blinded by an unexpected electoral victory or crushing defeat on May 6 could not fail to see that Greece faces the most urgent of economic problems. Figures released on Tuesday morning revealed that the Greek economy had contracted by 6.2 percent of GDP in the first quarter of 2012 compared to a year earlier. Many economists believe the economy will shrink by about 7 percent of GDP this year unlike the troika?s forecast for a contraction of under 5 percent.

The continuing deep recession is making any effort to boost public revenues a hopeless task. With revenues struggling, the weight is falling on public spending but Greece?s decision makers and its public administration have been unable to find smart and effective cuts to make. The public investment program, for instance, has been chopped to bits as a last resort, leaving almost nothing standing. The result is that Greece is still spending more than it can earn. Statistics published last week put the primary deficit (which does not include interest payments) for the first four months of the year at 1.68 billion euros. This is a significant improvement on last year when it stood at 3.56 billion euros during the same period but it still means that Greece is due to spend at least 5 billion euros more than it will raise in revenues this year.

On top of this, Greece has to pay some 7 billion euros in debt redemptions and coupon payments by the end of the year, 5.5 billion euros of which is due over the next three months. While the bailout agreed with the European Union and the International Monetary Fund will cover the debt payments through the escrow account created as part of the new bailout agreed in February, the question of how Greece?s primary deficit will be funded is less clear. Theoretically, the instalments from the loan package will go towards public expenditure but the eurozone held back 1 billion euros from a 4.2-billion-euro loan tranche a few days ago, showing it has few qualms about blocking Greek funding if there are reservations about whether Athens is sticking to the terms of the agreement.

The logical conclusion of this tactic is an internal default, which means that the Greek government would be forced to pay reduced pensions and salaries and freeze payments in other areas. It should be remembered that the state already owes about 6.5 billion euros in tax returns and to suppliers and that the General State Accounts Office has informed parties, including the Coalition of the Radical Left (SYRIZA), that Greece has enough money to cover its obligations until June or July at the latest.

Greek banks, waiting for the 50-billion recapitalization program to be completed, are equally short of cash. Since the crisis erupted in late 2009, banks have been losing an average of about 3 billion euros of savings per month. Due to bad loans and the debt haircut, their assets are virtually worthless. The only thing keeping them alive is the faith of some savers who have yet to withdraw their deposits and the trickle of financing from the European Central Bank. The latter, however, has recently come through the Emergency Liquidity Assistance scheme, which means the money is being lent by the Bank of Greece, which also holds the liability for these loans.

An internal default, which would cause social unrest and potentially a bank run, seems the mildest scenario given the current political instability and the absence of clear political solution even after new elections. The prospect of Greece crashing out of the euro and facing a potential financial disaster has now become a firm part of the debate in Europe. The problem is that when words such as ?default?, ?drachma? ?euro exit? or even the ?Grexit? moniker that some ascribe to such an event become part of daily discussion in the international media and the corridors of power in Brussels, Berlin and elsewhere, they begin to lose their negative value. They are gradually becoming neutral words and a Greek euro exit would be anything but a neutral event.

While many appear confident that a Greek default and exit could be contained, there is every indication that this is wishful thinking. First, there is the size of impact that can be measured: Bloomberg recently estimated that Greece?s total liability to the ECB is 172 billion euros and that Athens also owes about 200 billion euros to other official creditors such as the IMF and its eurozone partners. Almost three quarters of Greece?s debt now lies with the official sector but even this debt is more complicated than it first seems. The Wall Street Journal explained last week that while Germany has directly lent Greece 15.6 billion euros as part of the first bailout, the European Financial Stability Facility (EFSF) lent Greece 103.5 million euros. Germany has a 29 percent stake in the EFSF. The ECB holds about 50 billion euros of Greek bonds. Germany has a 19 percent share in the ECB. The German magazine Wirtschafts Woche calculated on Saturday that Germany would have to absorb 77 billion euros in losses if Greece leaves the eurozone and defaults on its debt. Although a worrying amount, perhaps Berlin believes that this is a shock to the system that it can withstand.

However, there is every reason to believe that the impact of a Greek exit would not be so neatly contained. The Economist wrote a few days ago that ?The panic would not be confined to Greece (which made up just 2.3% of the eurozone by GDP in 2011). Depositors in other vulnerable economies could take fright and try to withdraw their funds from their banking systems. Even if the European Central Bank (ECB) fought this with massive liquidity support, the crisis would shake already frail banks, especially in Spain.?

Speaking to Channel 4 on Monday, Charles Dallara, the managing director of the Institute of International Finance, which estimated a Greek exit could end up costing about 1 trillion euros, said: ?A Greek exit is so unlikely to be well-managed, so likely to be disorderly that it will pose a threat to financial institutions around the world but more fundamentally not just to financial institutions but to the global economy.?

The situation, therefore, looks grim for both Greece and its eurozone partners. In a sense, there is an unlikely and fine balance at the moment. Greece is suffering under the terms of the bailout but a potential euro exit is no panacea. In fact, it presents more questions than answers. The eurozone, meanwhile, is losing patience with Athens but cutting Greece loose does not seem a wise decision either.

The IMF warned on Monday that ?a political accident in the euro area could trigger a financial crisis engulfing the region.? In the current environment it would not take much on the Greek or European side to trigger such an accident. We should be under no illusions than when the balance is lost, we will all be hurt. The response from both camps must be to find a better balance, one that is not dependant on fear.

[Kathimerini English Edition]