Dr. Michael Arghyrou on reasons of Greece's recession and possible outcome of Nov. 20 meeting
Are there still any risks of Greece leaving the Euro bloc? What are the reasons behind Greece's prolonged recession and how long will it last? What agreement will the European officials reach on the 20 November, when they gather again to discuss details of the bailout? These are the questions, which Dr. Arghyrou addresses in the article dedicated to Greece's economic stance ahead of European officials' meeting next week.
Some specialists had projected that Greece would exit the Euro area by the end of 2012. Moving towards the end of the year, are there still any risks of Greece leaving the eurozone?
I believe that compared to the situation 6 months ago, the risk of Greece leaving the eurozone has somewhat receded. The reason is that Greece went through two general elections. In the second general elections the political parties that support maintenance of the Euro participation of Greece through the implementation of the Memorandum of Understanding emerged victorious. Although, it was relatively narrowly won general elections, it was still a victory for those parties that supported Greece's participation in the Euro's through implementing the reforms agreed within the context of the Memorandum. Thus, these were the developments, which have somewhat reduced the risk of Greece exiting the eurozone. Having said that, there are still risks that Greece may leave the eurozone, and these risks are basically internal and external.
The internal risk is mainly political. The current government is a three-party coalition government, and by nature this is a relatively fragile coalition. It includes the Centralized Conservative party, which is the main coalition party, but there are also other two parties: the social-democratic Pasok and the Democratic left party. Particularly, these two parties, Pasok and the Democratic left party, have to implement things that are not exactly consistent with the ideological base. It is always a risk that these two parties will not be able to continue participating in the coalition because of the internal strikes. That creates political risk, and if the present coalition government falls, then, of course, Greece may leave the eurozone.
Regarding the external risks, there are two main external risks. The first is that there is a significant part of influential policy makers, who would for a number of reasons think that it would be better for the eurozone, if the country left the Euro. They gained a lot of influence and a lot of momentum during the first half of 2012. Now it looks like these external observers that were advocating a Greek exit from the eurozone did not become the main stream view in the European policy making, but they still remain influential. Hence, if Greece missteps and deviates from its obligations, this may become a stronger view and eventually become the main stream view. The other external risk is what will happen to other eurozone countries, like Spain and Italy. If things start becoming shaky in those countries, if the Euro crisis becomes even worse than it is now outside of Greece, you never know what the repercussions will be on Greece.
Some finance ministers suggested that Athens should be given until 2022 to lower its debt to GDP ratio to 120 %, but the IMF Chief Christine Lagarde insists the existing target of 2020 should remain. To your mind, should Greece be given more time or not?
The disagreement is about basically, whether Greece would take an official sector haircut. Greece now has a public debt, approximately 150% of GDP, 17 % of which is now held by official lenders, which are European governments and the IMF. The IMF says that this is a very big debt burden and Greece must be given a debt relief on this official sector debt. That is why Mrs. Lagarde says that in order to bring down the public debt-to-GDP ratio to 120 % by 2020 effectively, the debt has to be written down, not completely, but take substantial haircut. On the other hand, there are countries in the eurozone, mainly the core EU countries like Germany, which say we cannot forgive the debt; however, we can prolong it into the future up to 2022. The Greeks may bring its debt-to-GDP down to 120% on their own by 2022.
Thus, everybody realizes that Greece needs some kind of debt relief, adjustments, and facilitation.
The issue lies not with the actions that have to be implemented by Greece. It is something that the IMF and basically Germany disagree upon, and the reason of disagreement is that Germany has difficulty in saying to its public opinion we have forgiven so much of Greek debts. I think that some kind of compromise will emerge. This is not a deal breaker.
Greece is heading for the sixth year of recession. How long do you think the recession will last?
A lot of people are wondering why and how a recession in a country can last 6 years in a row. However, this is not a surprising fact. In economics there are two concepts of income. First, there is the so-called observed income - what you see, what you observe, how much money people earn in reality. Another concept is the so called equilibrium income that is to say the amount of spending that is justified by the economy, competitiveness. Greece for a long period of time between 2001 and 2009 had an income, which was significantly higher than the equilibrium income. In other words, people in Greece were lending money beyond what the country could produce and the extra income was coming from foreign loans. Between 2001 and 2009 this output gap, as it technically called, cumulatively was in the order of 40 %. Thus, the Greek population was mainly driven by wage increases in the public sector that got 40% in cumulative terms more purchasing power than they should have. As the old economy has gone into this global credit crunch, it is not possible any more to finance these incomes with extra loans. Thus, it is very understandable that Greece went through this very prolonged recession. This is an equilibrium phenomenon. It is basically due to the fact that the economy has started now paying what it can afford, because it cannot borrow anymore.
Hence, there is nothing surprising in this recession as it is an equilibrium recession. It cannot be avoided, but it could be managed. The recent data shows that Greece has now basically returned to the level of incomes and the level of economic activity that is more or less consistent with its production structure. I would say that we are now nearing the end of recession. Probably this and the next year will be the last years of recession. However, if things go the wrong way, and if Greece mishandles its policy and continues to have the uncertainty surrounding it and people do not know where exactly the country will go, then there might be an even deeper recession, which will not be due to the production structure, but due to the uncertainty, i.e. everybody will be waiting to see what will happen, nobody will not be spending money. However, there are good reasons to believe that this or the next year will be the last year of the recession.
What agreement do you think European officials will reach on November 20, when they gather again to discuss details of the bailout?
We know that Greece has delayed implementing the reforms demanded by its rescue creditors. However, in all fairness we have to admit that the present government has done a lot and after delays it passed through the austerity measures. I think Greece has provided the necessary base for the European partners to help it out by means of releasing 31 billion euros of the transfer that the Greeks did not receive in June. I would expect that very soon, maybe it will not be exactly on 20 November, but it could be on 3 December, hence within the next 4 weeks they will agree to provide Greece with extra money, which has not yet been released. I also expect that they will probably reduce the interest rates on Greek loans that other European governments hold. However, I am not sure as to whether this disagreement between the IMF and the European Union will be resolved within the next 4 weeks. I expect release of the money and Greece would be given some relief in terms of lower interest rate and later on they will somehow agree on this issue of controversy - should they allow more Greek public debt or should Greece be given extra time. Definitely Greece will be given some extra 2 years in order to meet some fiscal targets in 2016, not in 2014 as it was expected.
Moreover, if there are no accidents in Greece, if they carry on with the present reforms, I would expect that there will be that haircut on the official sector's loans, but it would probably be delayed until after German elections. I think this is the most sensible scenario for Greece to show in practice that they mean business.