Grateful Greece under grace
View(s):At least there is one thing in common between Greece and Sri Lanka: High government spending with “loads of handouts” which has been financed by borrowings!
What is not common is that when Greece got into trouble with this, there are 18 nations around it to rescue either willingly or grudgingly. They are the nations of the member states in the Eurozone. They must rescue Greece, if not for Greece, at least for themselves.
My attempt is, however, to bring out in a nutshell some economics out of the whole story of the debt problem in Greece. It is important for Sri Lanka too at a time that we are already borrowing to pay our public debt, which has got piled up from previous borrowings. Greece was there during the past eight years, but narrowly escaped “defaulting” the payments as others rescued it every time.
Final bailout
Greece has an outstanding massive public debt pile, which now amounts to EUR 325 billion (about US$380 billion) and, equivalent to about 180 per cent of its GDP.
Its unmanageable nature was exposed by the global financial crisis that spread from the US to Europe.
One good thing about periodic economic cycles and crises is that they expose weak areas of economic mismanagement and discipline the nations to accept prudent economic reforms.
After eight years of suffering with hardship and uncertainty coupled to Eurozone’s bailout packages – all due to its huge public debt pile, Greece is now breathing with a relief. The member states of the Eurozone have come to an agreement for the final bailout – to allow Greece to extend and defer the repayment of its debt for another 10 years and to give EUR 15 billion new credit. What a grace!
The final bailout by the Eurozone member states under this deal will be on August 20. During the past eight years, Greece has received continuous financial support amounting to about Euro 275 billion in total.
On some occasions, when the due repayment date was round the corner Greece was not ready and about to default; but the European Union, European Central Bank or International Monetary Fund came to the country’s rescue. A few times Greece was also on the verge of falling from the Eurozone.
Exposing the problem
If you are spending lavishly out of unavailable wealth, apparently you must have been borrowing even if you don’t say it. This is what happens to many nations that keep spending money that was not yet generated. Anyway, the problem is even borrowing has a limit, because you should be able to manage the repayment of your loans without borrowing again for that.
With a negative rate of growth in 2009, about $25 billion out of its $355 billion economy of Greece got wiped out. With this its budget deficit rose to 15 per cent of GDP and the stock of outstanding public debt to 130 per cent of GDP.
In this file photo taken on July 27 the full moon is seen during a “blood moon” eclipse over the temple of Apollo in Corinth. The International Monetary Fund on July 31 urged Greece to be “realistic” about its economic goals, and reiterated the longstanding concern the country may yet need additional debt relief. The IMF board welcomed the agreement Athens reached with the European Union in June to reduce the country's debt burden over the next five to 10 years but said it may be insufficient given the potential for political opposition to further reforms. / AFP PHOTO
Interestingly, the member states of the Eurozone “single currency union” had the obligation to maintain public debt below 60 per cent of GDP and the budget deficit below 3 per cent of GDP. Anyway, it was not only Greece, but many others in the Eurozone had already gone beyond the boundary lines. But the problem was “what could be done,” if the members don’t honour their obligation?
As the problem got exposed, credit ratings continuously declined and investor confidence deteriorated. If you are an investor in the Greece security market (being a lender to the Greece government), what would you choose to do in such a situation?
Panic investors
Investors in security markets or, in other words the lenders to the governments, began to suspect whether the government had failed to give them the expected return. With this speculation, there was a panic. I must stress the point that in economics, “even if public speculation is wrong, at the end of the day it will come true.”
In a panicking security market, investors want to get their money back and get out of the market. This means that on the one hand, there are plenty of sellers, but on the other hand, there are no buyers. The government is in trouble as borrowing becomes difficult now, but at the same time it has to pay for investment withdrawals.
As a result, interest rates begin to rise. The 10-year bond rate which was around 4 per cent in 2008 increased to 48 per cent within the next four years. This means that if the government intends to borrow it has to offer that much higher interest rate to the lenders compensating for the risk. But who would dare to lend even at that rate, given the high risk of losing money.
Interest rate is tricky
Interest rate differences among member states in a single currency union is a tricky point. In fact, the Eurozone members also had the obligation to maintain fairly uniform long-term interest rates which cannot be more than 2 percentage points above a given average.
What would happen, if there are interest rate differences? It would create disturbing financial flows among member countries putting the “single” currency in trouble. But the countries which tend to borrow more would naturally create pressure on the interest rates. When they agreed to be in a single currency union, effectively the Eurozone members are not in a position to make use of their monetary policy.
The member states should give up the monetary policy autonomy for the sake of the union; then it is the monetary policy of the union and not of the individual countries. But excessive borrowings by some of the member countries in the Eurozone were harmful to the uniformity in interest rates.
Prosperity on debt
As the prosperity based on borrowings was shaken, the Greece economy faced hard times. The government began to adopt the policies called “austerity” measures under pressure from the European Union, the European Central Bank and the IMF. Public spending was drastically reduced with cuts in government jobs, salaries and wages, pensions, and other benefits, handouts among others.
But economic growth remained negative until now for most of the years, while unemployment rose to more than 25 per cent of the labour force. It is a breeding ground for political unrest; there was no shortage of political turmoil in Greece including frequent public protests against austerity measures and hardship.
The European Central Bank and the member countries in the Eurozone also continued to provide bailout packages which usually came up with severe austerity measures aggravating the hardships of the public.
Referendum in 2015
As another bailout package with austerity conditions was prepared in 2015 by the European Union, the European Central Bank and the IMF, the Greece government held a referendum. The people had to decide whether they accept the bailout conditions or not! Over 61 per cent of the people with the support of the government voted against. Alas, Greece wanted bailout money without conditions!
A few days later, Greece presented its own package for bailout money amounting to Euro 86 billion from the member states of the Eurozone. The lenders accepted the conditions of the borrower! Eurozone members approved the bailout package.
Puzzle
I know that this story raises more questions than answers. However, I must take at least one puzzle: You must be wondering why on earth such a grace! It is because most of the investors in Greece bonds are from the Eurozone member states themselves. By extending grace to Greece, they are helping themselves not to fall down. And after all it is the Eurozone and not individual countries.
(The writer is a Professor of Economics at the Colombo University. He can be reached at sirimal@econ.cmb.ac.lk)