The current discussions between the new Greek government and its euro area partners have raised many questions and comments on Greece’s debt level and the need for debt cancellation measures. The goal of this note is to suggest that greater importance should be given to economic growth than to debt cancellation.
It is urgent to give a chance to negotiations
A decision to restructure the debt would have almost no impact on Greece’s underlying budgetary position in the short to medium term because the debt service paid by Greece on its debt is modest. A write-off of some debt would be a symbolic victory for the Greek government, but the morning after, it would be facing the same economic challenge as today. Syriza should therefore accept to start negotiating without requiring a commitment to debt cancellation.
For their part, euro area finance ministers should make a concession by accepting to engage discussions on a new program rather than requiring that the new Greek government sticks to the current program as a condition for further assistance. This requirement, if maintained, would place Syriza in a very difficult situation, which could trigger a crisis and open the exit door from the euro area. Instead, Greece’s partners should give the Greek government a chance to demonstrate its seriousness to negotiate a sound reform program.
In the meantime, the Greek government should avoid taking policy measures that could be seen as being provocative by other euro area members. And steps should be taken to ensure that Greece has the funding necessary to avoid a default of payment. This is an urgent matter given that Greece’s current program expires at the end of February. Also, it should be borne in mind that helping Greece cover its financing needs over the next few months would have a negligible impact on the overall exposure of the euro area to Greece, as the purpose of the new funding arrangements would be to serve to roll over existing loans and maturing debt.
Reviving growth should be the priority
The best interest of the two sides – the Greek government and its European partners – is that Greece gets back on a path of strong and sustainable growth as quickly as possible. To be mutually acceptable, this path should be based on two key objectives: maintaining an appropriate level of primary surplus to reassure Greece’s partners and protecting Greece’s poorest citizens from the worst effects of the crisis to respect the electorate mandate received by Syriza.
If the negotiations succeed in developing a program enabling growth and jobs creation, Syriza is likely to continue to insist on obtaining some form of debt relief in order to bring Greece’s debt to more sustainable levels. Hopefully, Greece’s partners will agree to accede to this request, possibly by offering more generous terms of reimbursement. It will be up to Syriza to decide to take a very hard line in these discussions, at the risk of hampering the growth prospects which the implementation of the program would open up. It should also be recalled that the debt ratio is not a good indicator of the sustainability of public finances in Greece because Greece has already benefited from important reductions in its debt service obligations.
If, on the other hand, the short-term growth outlook appears mixed and uncertain, Syriza would be right to propose to rethink the economic strategy forming the basis of the program. And considering that debt cancellation measures would not fundamentally improve the situation, it would have to consider alternative policy measures.
To exit or not to exit
One obvious reason why the projected resumption of growth could remain weak is that the program would lack enough measures to stimulate aggregate demand. Even if it is agreed to revert some of the less-popular austerity measures included in the current program, it is unclear that Greece has enough budgetary room of manoeuver to stimulate consumption and investment, at the least in the short term. It is a familiar situation to many countries which call on the International Monetary Fund (IMF) for help. In general, faced with this situation, the IMF recommends a devaluation of the currency to offset the potentially adverse impact on growth of tight fiscal policy and structural reforms by a boost to competitiveness to stimulate the country’s exports.
Obviously, the IMF has not recommended this strategy because Greece is part of the euro area. It is also widely accepted that an exit from the euro area would be a very difficult operation to manage, with adverse consequences for economic growth and the most vulnerable groups of society.
These considerations shed some light on the likelihood that Greece could in the end abandon the euro.
If the new Government is not serious about reforming its economy, sooner or later Greece will default on its debt and leave the euro area. Without accepting far-reaching reforms, the Greek government will not succeed in putting together a credible program. And everyone will have to draw the conclusion from that. The sole uncertainty is who is going to pull the plug first.
If, however, Syriza engages in good faith in negotiations, we will need to wait and see how the program will impact Greece’s economic growth. If, in the end, there is no convincing evidence that growth will not come back sufficiently strongly, a solution will need to be found to be able to keep Greece in the euro area.
An ambitious investment program for Greece
One obvious approach would be to include in the new program a very ambitious investment program to stimulate aggregate demand in the short term and improve the foundations of Greece’s economy.
Four key reasons could justify following this route:
- The Greek government would have demonstrated its willingness to implement a serious reform program.
- The failure of the current program in terms of debt dynamic and growth prospect justifies trying another way.
- The unusually high level of the debt justifies to give special treatment to Greece, especially since the investment program for Greece would also boost exports from other euro area member countries.
- Last but not least, this step would help avoid the major disruptions that a Grexit would cause.
The end result of the negotiations on a new program will crucially depend on the seriousness of Syriza and the possibility to develop a strategy that would allow Greece to return to growth without exiting the euro area.
Without giving a chance to negotiations, Greece’s partners won’t be able to clarify these uncertainties. And Syriza might decide to abandon the euro for the wrong reason.