Help Greece Save Herself

On Friday, April 24, the Greek government requested the IMF and European Union to activate the agreed 45 billion euro loan. The request came just a day after Moody’s downgraded the Greek debt (from A3 to A2) and Eurostat revised its estimate of the 2009 government deficit to 13.6% (up from 12.7%) of GDP. S&P followed soon.

On Monday 27, the agency lowered the long- and short-term sovereign credit ratings on Greece to BB+ and B, respectively, from BBB+ and A-2. . Yields on Greek 3 year- bonds shot up to 14%, the 5-years bond to 12.9%, and 10-years bond to 9.8 per cent. CDS spread to insure against Greek sovereign default now exceed those of Pakistan, Ukraine and Iraq(see Table 1).

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The dramatic acceleration of the Greek crisis has many explanations. The urgency stems from the fact that Mr Papaconstantinou, the  NYU and LSE trained Greek Treasury Minister, has to raise 2.3 billion euro to pay the interest coming due on May 10, and, without the EU and IMF help, is bound to face a roll-over crisis when  8.1 billion of debt come to maturity on May 19. In Athens, unions are taking the streets against budget cuts. At the same time, popular hostility is mounting in Germany, and Chancellor Merkel, on the eve of the North – Rhine Westphalia elections, is myopically pulling the brakes. The unfolding of the crisis raises at least two questions. The first is whether it is still possible to “save” Greece. The second is how much would it cost to help Greece to save herself.

Can Greece Be Saved?

Even if it looks quite difficult, the answer is yes. Surely, left to herself, Greece is doomed to fail. With a debt at 125% of GDP, an average interest rate close to 7.5% in real terms and the economy in recession, a back-of-the-envelope calculation shows it would take budget cuts of above 15 percentage points of GDP in order to stop the explosion of public debt, see Table 2. Even if diluted over time, such an adjustment would be neither feasible nor desirable. Yet the explosive growth of public debt is largely due to interest payments. Hence, cheaper international credit lines (the Stand-By Agreement by the Fund, and the loans from the EU) could greatly improve things. For example, if the Greek government were able to borrow at a nominal rate of interest of 3 percent (as the Stand-By Agreement seems to imply), with a little luck (inflation and growth at 0.5%), the required adjustment would be halved. That would still require harsh, but now feasible, sacrifices from the Greeks (see Table 2, scenario 2)

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How much would It Cost To Help Greece Save Herself?

The answer is not much. The Greek GDP in 2010 is about 2.6% of the euro area GDP (Source: IMF data mapper).Hence, this interest rate subsidy (4% on a debt of 1.25 times the Greek GDP), would cost the euro area only 1.3 per thousand pointsof GDP (= 4% x 1.25 x 2.6%), about 12.5 billion euro. In an optimistic scenario, a credible and realistic program of budget cuts in the order of 7-8 point of GDP could be implemented over 2-3 years, under the careful supervision of the Fund. The pessimistic scenario would materialize if the Greeks systematically delay the adjustment. The Fund and EU should then leave Greece to its fate, and prepare an orderly restructuring of debt.


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