As Greece activates its 45 billion euro ($60 billion) rescue package with the International Monetary Fund and the European Union, it is becoming clear that a new, far more comprehensive approach is needed. Two problems need to be addressed: the credibility of Greece’s fiscal stabilization program, and how to cover the country’s medium-term financing gap.
The magnitude of the fiscal adjustment effort being demanded of Greece is now well-known. The deficit has to be reduced by at least 10 percentage points of gross domestic product. The key problem, which has not been addressed so far, is that a fiscal adjustment on this scale requires the government to take two steps that can be implemented only with wide social approval: a cut in wages and a cut in social expenditure. Both steps are now as unpopular in Greece as they are unavoidable.
The government can — and has — cut wages in the public sector, but this is not sufficient. A large cut in private-sector wages is also urgently needed to stimulate exports to create at least one source of growth.
Deep cuts in social spending are also unavoidable to achieve sustainable public finances. The growing fiscal deficits in Greece over the last decade were essentially the result of a massive increase in the size of state social benefits, fr om 20 percent to close to 30 percent of GDP, without any significant increase in tax revenues.
Contrary to popular perception, the public-sector wage bill is only of marginal importance. The government has already forced through most of the necessary adjustment in this area.
Indeed, cuts in public-sector wages can yield at most 2 percent of GDP in fiscal consolidation. Given that social expenditure amounts to close to 60 percent of total public spending, a successful fiscal adjustment will ultimately require that it be cut significantly. The alternative, an increase in tax revenues by almost 50 percent in the span of a few years, simply is not feasible.
Profound reform of the welfare state and building a modern tax administration system requires time. But financial markets are in no mood to give Greece time, which brings us to the second major problem facing the country.
To gain the breathing space necessary for the reform process to be effective, the Greek government could just announce a simple rescheduling: the due date of all existing public debt is extended by five years at an unchanged interest rate. In that case, the Greek government would face no redemptions for the next five years and would have to refinance about 30 billion euros per year from 2015 onward, which should be manageable by then. Official financing needs would then be much more lim ited, and the IMF and EU package of about 45 billion euros should be sufficient to cover most of the progressively lower deficits over this grace period.
Without such a rescheduling, it is unlikely that Greece will be able to roll over the 30 billion euros maturing annually for the next few years. Over time, the euro-zone countries would inevitably have to refinance most of Greece’s public debt.
This is a recipe for continuing political problems, as the Greeks would always consider the interest rate too high, while Germany would consider it too low. Moreover, once the euro zone had started refinancing Greece without any contribution from private creditors, it would be politically impossible to stop.
The type of rescheduling proposed here would signal the Greek government’s readiness to service its debt in full and thus might be accepted without too much disruption in financial markets. Of course, markets would view any rescheduling without a credible adjustment program merely as a prelude to a real default later on, thus leading to an even higher risk premium.
But even the best adjustment program cannot be financed without some contribution by private creditors — that is, some form of rescheduling. The only way out for Greece is thus to combine both elements: rescheduling its debt, plus national agreements on wages and social expenditure. The current approach — concentrating only on the financing needs and fiscal adjustment in 2010 and leaving all the hard choices for later — will not work.
Daniel Gros is director of the Centre for European Policy Studies in Brussels. © Project Syndicate
A Message from The Moscow Times:
Dear readers,
We are facing unprecedented challenges. Russia's Prosecutor General's Office has designated The Moscow Times as an "undesirable" organization, criminalizing our work and putting our staff at risk of prosecution. This follows our earlier unjust labeling as a "foreign agent."
These actions are direct attempts to silence independent journalism in Russia. The authorities claim our work "discredits the decisions of the Russian leadership." We see things differently: we strive to provide accurate, unbiased reporting on Russia.
We, the journalists of The Moscow Times, refuse to be silenced. But to continue our work, we need your help.
Your support, no matter how small, makes a world of difference. If you can, please support us monthly starting from just $2. It's quick to set up, and every contribution makes a significant impact.
By supporting The Moscow Times, you're defending open, independent journalism in the face of repression. Thank you for standing with us.
Remind me later.