Greece – The day After: Time for a Fresh Start?

The breakdown of negotiations between Greece and the Troika comes as a shock. It is not, however, the end of the game. This column argues that the rupture can serve as a starting point for a new relationship between Greece and its creditors – an approach that does not provide fresh cash to the Greek government and does not impose specific policy reforms from outside.

The open conflict between Greece and its 18 Eurozone partners and the impending expiration of the assistance program on Tuesday is a dramatic climax to a long-running saga. Over the past six years, the Eurozone has changed its character and institutional structure, while Greece has gone through a profound socio-economic and political crisis.

While seen by some observers as end-point to a failed crisis resolution, I will argue that it should be the beginning of a new dialogue, building on the difficult lessons of the past years and using the new institutions and possibilities in place within the Eurozone. Whether Greece stays in the Eurozone or leaves it, is only one of several important decisions to be taken in Athens, though with support by Frankfurt, Brussels and Washington.

The Greek Eurozone learning curve

The past six years have provided a steep learning curve for the Troika.

• What some billed a liquidity crisis in the early days of the crisis turned out to be a solvency crisis, with Greek debt unstainable under any reasonable growth projection.
• What seemed like a case of restoring competitiveness turned into the need for deep structural reform.

The ultimate stumbling block was the lack of ownership – in Greece itself – of any form of serious reform. While adjustment programs and Troika were rarely welcomed with joy across Europe’s periphery, there was an immediate and profound rejection of the “memorandum” and any reform attempt related to the Troika in Athens. The “money-for-reform” approach has found its limitations.

Greece vs Troika – the classical hold-up problem

After the 2012 sovereign debt restructuring and a shift of privately-held Greek government debt onto the balance sheets of the rest of the Eurozone’s governments, there was the pretence that the problem was solved, Greece was on good way to recovery, and taxpayers in the other Eurozone countries were safe from further bail-out demands. The reality is that the high exposure of the Eurozone countries to Greece is a classical hold-up problem – refuse further funding and Greece might default on its existing debt; let Greece leave the Eurozone and not only will the current debt pile become even less sustainable, but the country would require additional emergency funding from the European Union. After this weekend and the refusal of the Troika to provide further funding under existing arrangements, this reality has become even clearer. The path of crisis resolution over the past five years has led to a long-term dependency of the Greek government and society on taxpayers in the rest of the Eurozone. Recognizing the losses and this dependency, however, is politically very difficult for the Eurozone.

From fiscal to political constraints

Short maturities with frequent roll-over of loans and loan covenants (requirements for the borrower to either undertake or refrain from certain actions and activities) are a solution in corporate finance to overcome problems of trust between borrowers and lenders. Similarly, the Troika has tried to keep Greece on a short leash, releasing money only against very specific policy actions, increasing political tensions further. From the viewpoint of creditors this approach makes perfect sense in order to avoid throwing more good after bad money and to enhance political accountability vis-à-vis their voters and taxpayers; from the viewpoint of Greece this involves even more micro-management and loss of national sovereignty. On both sides, political constraints became tighter and tighter; as the can was kicked down the road, the political scenery along the road became uglier and uglier, with protest and radical parties gaining ground across the Eurozone.

HIPC-back to a better future

The game is not over until it is really over! There seem few solutions to cut the Gordian knot. One way forward, consistent with the objective of reducing tensions and political constraints is to stop any further fresh loans for Greece in the foreseeable future. At the same time, further repayments of existing loans should be delayed for several years. This would force the Greek government to work within a hard budget constraint and an effectively balanced primary budget (before interest and debt repayments). While this seems unfair to other highly indebted countries, including Italy, Portugal and Spain that are forced to run primary surpluses, it takes account of the complete lack of access by the Greek government to debt markets. On the other hand, it would free the rest of the Eurozone countries from political pressure to justify further lending to a Greek government seemingly unwilling to reform vis-à-vis their electorates that get increasingly frustrated and polarized.

What to do with the unsustainable high level of Greek debt? Even at the current repayment schedule of the restructured debt, the debt burden was extremely low for Greece. Nevertheless, the question of the debt remains. Here a solution similar to the HIPC Initiative might come in handy. Launched in the 1990s by IMF and World Bank this program aimed at reducing unsustainable levels of debt in many low-income countries, linked to specific performance criteria in social and economic policy. Similarly, one can envision a reduction in the Greek debt level over time linked to broad performance indicators reflecting institutional quality, macroeconomic management and openness of markets. Rather than focusing on individual laws and regulations, regarded as political interference and micro-management in Greece, broader performance indicators should be reviewed every few years and thus linked to further debt relief. Going forward, this could also imply a more prominent role for other IFIs beyond the IMF, including the World Bank and the EBRD, both institutions with extensive experience in institution building and private sector development.

In or out? And what about the banks?

Greece cannot be forced to leave the Euro. If the government decides to print its own money (such as in the form of IOUs) – in itself a legally risky manoeuvre as it contradicts European treaties -, this would be a first step towards Grexit. More short-term, a collapse of the banking system cut off from liquidity support of the ECB could trigger a collapse of the Greek economy and ultimately force a Grexit. Without a banking system that supports the real economy through payment system and money creation and forced to go back to a cash economy, alternative forms of payments would arise quickly and the pressure to establish a new domestic currency. The adjustment period would be more than painful and would certainly require support from outside.

Is there a way to avoid this? Given the high share of Greek government debt held by Greek debt, a fresh government insolvency plus the impending new recession would turn Greek banks insolvent on a forward-looking basis, which would have to trigger action by SSM and SRM, the two pillars of the newly created banking union. Restructuring the banks and isolating them from the government (i.e. avoid any unsecured lending to the government) would be the only way to maintain a Euro-based financial system. Recapitalizing would have to involve the ESM, but – if done well – could turn into the first success story for the young banking union. Greece would still have a banking system at a fraction of its size pre-crisis and of limited support for the Greek economy, but it could serve as the anchor to maintain Greece in the Eurozone and could be the core of an economic recovery within the Eurozone. And this action would ultimately achieve what has been the objective of the banking union – cut the links between government and bank fragility at the core of the Eurozone crisis.

Ultimately, the decisions will be taken in Athens, not Brussels, Washington or Frankfurt

It has become clear that the clientele-focused political system is at the core of the socio-economic crisis in Greece. Only a change in that system and substantial institutional changes can return Greece on a long-term sustainable growth path. Analyses of the necessary steps towards such structural changes are plenty, and international willingness to help seems still forthcoming, the impetus to implement them, however, has to come from inside the Greek society. The new approach should be to provide space for this internal debate, not fresh money tied to conditions.

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