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Business News/ Opinion / Avoiding a Greek tragedy
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Avoiding a Greek tragedy

The pressure to close the fiscal gap and make reforms that improve competitiveness cannot be let up

Photo: Alkis Konstantinidis/Reuters Premium
Photo: Alkis Konstantinidis/Reuters

Let me present a novel solution to the Greek tragedy. Tying interest payments to both economic growth and fiscal discipline would satisfy the current interests of borrowers and creditors and could be done in a manner that promoted future discipline.

Any solution to the current impasse must satisfy some tests. First, the primary budget surplus required of Greece must not be so large as to inhibit sustainable economic growth. By primary budget surplus we mean revenues less expenditures, excluding interest or debt repayments. This is a better measure of a budget’s impact on economic activity than the overall deficit. When animal spirits are low, the multiplier of fiscal conditions on to consumer investment and business investment is high. And without gross domestic product (GDP) growth, there can be no stabilization of the debt-to-GDP ratio. The troika of the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) argue that despite Greece’s near 4% primary budget surplus—the largest in Europe by far—Greece is on the threshold of positive growth for the first year since 2007. Stick to the programme they say. But GDP hitting bottom after collapsing by 25% is not a sign of success.

The lessons of economic history, be it during the 1980s in Latin America or in Germany between the wars, is that paying a foreign tribute on such a scale is inconsistent with economic growth and political stability. The current bailout plan does not pass this test of viability.

But growth cannot simply be purchased through more borrowing from the same creditors with fiscal policy stuck on an unsustainable path. The pressure to close the fiscal gap and make reforms that improve competitiveness cannot be let up. Recall that Greece has required not one bailout, but two—the €110 billion package in 2010 and a further €130 billion in 2012—and is seeking a smaller third injection of funds as well as the rewriting of the terms of the first two. Just as borrowers should not be enslaved to creditors, foreign tax-payers should not be enslaved to debtors. Greece’s current proposals do not pass this second test.

Fiscal conservatives fret that an easy solution today would encourage fiscally irresponsible behaviour in the future. But Greece’s current predicament is not a negotiation strategy, it is a human tragedy: output is down 25%, over 100,000 businesses have shut, unemployment has trebled to over 20% with youth unemployment over 60%.

The real moral hazard is that those who benefited from the financing and unfunded expenditures in the years preceding 2010—including the international financiers and local oligarchs—are not the ones vulnerable to the cuts in safety nets today. Similarly, there is often a tendency to focus on teaching debtors a lesson, but for every excessive borrower there is an excessive lender. Access to the special arrangement we discuss below should only come about after private sector creditors have sold all of their debt to the public sector at 50% of face value ensuring there is no incentive to lend in hope of a generous special arrangement in the future. To avoid debtors going that route creditors will ensure they fear the prospect of being shut out of private capital markets for a while.

A non-economic test for a sustainable solution is whether it provides room for self-determination. There may be legitimacy to creditors demanding a primary budget surplus target, but little to them demanding how a democracy achieves that target. To impose external requirements for Greece to cut its social protection and privatize public assets is asking for trouble. Especially as it forces faulty nationalist prejudices onto an already sensitive area.

Contrary to average ill-informed opinion, Greece’s public expenditure as a per cent of GDP around 47%, is little different from Germany or other countries. Except in the case of defence spending, its allocation between social services and other items is little different too. Greece’s fiscal exceptionalism is its poor tax collection. The new government’s desire to disrupt the hold under-taxed oligarchs have on the economy and budget and to repair social safety nets, is a better position morally and economically than much of what has been imposed in the name of Europe.

Having purchased all the debt at 50% of its face value—as has largely occurred—the troika of EC, ECB and IMF should reset the interest rate to the percentage level of nominal economic growth, minus the percentage level of primary budget surplus, as calculated by Eurostat. The key to debt sustainability is for interest rates to be lower than nominal growth, and for there to be primary budget surpluses when growth is strong, not weak so let us embed that into the formula. Back in 2010 as growth turned sharply negative, interest payments would have dropped further that they did providing additional room for a less restrictive budget. Given the fiscal multipliers, growth would have arrived earlier, pushing interest payments back up. To keep interest rates from rising too rapidly with the recovery in growth, the government would be incentivized to run bigger primary surpluses.

If growth slipped back there would be automatically new room to support growth, but not to run large primary deficits, as that would raise interest rates with debt levels following, closing off access to private capital markets. Under this framework the right discipline is automatically applied at the right time, making it better than a default and less politicized too—no need to welcome the troika’s viceroys to Eleftherios Venizelos every month. If this framework had been in place in 2010, Greece would have a lower and declining debt-to-GDP ratio with more growth and less strife.

Avinash Persaud is non-resident senior fellow of the Peterson Institute for International Economics in Washington and non-executive chairman of Elara Capital.

Comments are welcome at theirview@livemint.com

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Published: 23 Feb 2015, 04:36 PM IST
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