Monday, 16 February 2015

Greece-EU agreement: not today but eventually

There are some ideas circulating around about Greece defaulting on its official debt, staying in the Euro and issuing IOUs (effectively a parallel currency) to run a more expansionary fiscal policy.

Let's keep the feet on the ground for two minutes. 

The problem for the Greek government is not related to its ability to spend more once it has defaulted while staying in the Euro. With a 4.0%-4.5% primary government budget surplus expected for 2015, the Greek government has enough room to increase spending following a default on its official debt (80%-85% of total).

The problem is twofold:

1. It's banking system being cut off from ECB financing. This can be possibly solved by imposing capital controls. Not an elegant solution but a solution.

2. The external financing constraint. Greece is running a current account surplus of 0.5%-1.0% of GDP. Once it defaults, the current account surplus will actually increase as interest payments to foreign (official) creditors stop being made. This will allow to finance the initial additional imports of good and services that a more expansionary fiscal policy will trigger.

However, as the economy starts to grow it will need to import more to sustain the growth. Current account deficits will ensue. But without access to external finance - who will lend money to a country that just defaulted, even if only on its official debt, and since 1980 has run current account surpluses only in 2013 and 2014 ? - these deficits cannot be financed. No current account deficit can be run. And this will put a limit on growth and employment creation. Goodbye Syriza popularity.

The only way to overcome the external constraint sustainably over time is by broaden and expanding the country's export basis. This in turn can only be done via attraction of massive amounts of foreign direct investment (FDI). But a country that just defaulted will be able to do everything but attracting massive amounts of FDI.

Cutting a long story short, without structural reforms to attract FDI and to broaden its export basis Greece will never be a highly developed, modern, prosperous country. With or without default. With or without Grexit.

And the question then is: will it be easier to carry out the needed structural reforms within the discipline-pressure-conditional support-framework provided by the Euro or outside the Euro? Who says outside the Euro is ignoring Greek history.

As Syriza's government surely doesn't ignore Greek history, understands economics and is led by a smart political operator (here more on the topic), it will eventually reach an agreement with the EU for a new financing programme (lower primary budget surplus and further debt maturity extensions / lowering of interest rates in exchange for structural reforms).

Will it happen today, 16 of February 2015? I don't think so. The members of the new Greek government may be intelligent and well intentioned but they are inexperienced operators coming from another universe: lifelong academics and lifelong politicians. They have no executive experience at the highest level. And this means that they will be more likely than not poorly prepared for today's Eurogroup meeting. Able to do a lot of talk but with very little structure. And without structure and solid quantification of reality negotiations can't reach a swift conclusion.

But don't panic. Eventually an agreement will be reached. Just not today.

No comments:

Post a Comment