With the advent of autumn, the crisis in Greece has entered a new phase. Summer electoral euphoria has faded, holidays are over and society is once again faced with the biggest problem - how to achieve a sustainable economic development model. The Centre for Planning and Economic Research is active in this area and its experts consult the representatives of international creditors during their visits to Athens. Professor Giannis Monogios manages the fiscal and monetary policy department and advises the Minister of Finance Yiannis Stournaras. Maria S. Topalova talked with him not only about the sustainability of Greek debt and the sources of economic growth, but also about widely discussed financial terms such as OSI and GREXIT.
A study of yours published last week found that the situation regarding the Greek debt has deteriorated in recent years, while one would expect the opposite - for it to improve. Could you explain why?
There are a number of reasons that have brought the ratio of debt to GDP to levels higher than those of 2010. The truth is that the main reason is the deeper than expected recession than expected in the country, which has been continuing for five years now and positive growth is not expected before 2014 or 2015. Therefore, the main reason for the increase in debt, despite the PSI haircut, is that the recession has been deeper and we also have primary deficits, which are added to the debt and increase its size.
We see in your study again that servicing the Greek debt is possible in 8 favourable scenarios. Which of these are likely to happen?
Last week, the Centre for Planning and Economic Research announced the results of a study, which aimed to explore the extent to which the Greek debt could be serviced. According to the second Memorandum, the Greek debt, as you know, has to reach 120.5% of GDP. At present, in 2012, we believe that the debt will be around 166% of GDP at the end of the year. So, we studied whether this ratio of 166% could reach 120% and developed 8 alternative scenarios. In practice, there are 4 scenarios and 4 alternatives to them based on certain assumptions about how the economy would develop from now on. We used the growth rate of GDP from a macroeconomic model that takes into account the change in GDP, interest rates, as they would develop by 2020, the formation of primary surpluses necessary to reduce the ratio of debt to GDP and we studied the extent to which this debt could be serviced. In practice, in 7 out of the 8 scenarios, the debt does not seem to follow a sustainable development model due to the reasons I previously mentioned. Therefore, it seems that it cannot be servicedin the absence of a targeted intervention to reduce the debt. In the last scenario, the ratio of debt to GDP stands at 118%, more specifically 118.4%, but is still based on assumptions that I will immediately state. Remember, however, that we are talking about scenarios; these are not forecasts but approximate estimates. Therefore, the results of the analysis are as reliable or accurate as the assumptions we make about them. If our assumptions change, the results will obviously be different. So, I will examine the last scenario where servicing the debt is possible, but under certain conditions. These conditions are basically four in number. The first condition is a return to positive growth rates in 2013 or 2014 and onwards, and possibly a lower average interest rate on the existing debt. Currently, the interest rate is around 4% in real terms, and in our study, we believe that a rate of about 3.5% would be very useful for debt sustainability. In addition to the lower interest rate, we developed scenarios where the fiscal adjustment to the amount of 11.5 billion euro cost cutting would be implemented for two or four years. The third condition we used was the assumption that the amount needed to recapitalize the Greek banks to the amount of around 45 billion euro, which they would obtain through the second Memorandum, would not be added to the national debt and would not worsen its ratio to GDP. Instead, it would come through the permanent European Stability Mechanism (ESM), which will start to function. This extremely important parameter needs to be studied because this automatically reduces the original amount of the debt and it is easier to service a lower level of debt. The last hypothesis formulated is that the privatization programme is progressing on a more realistic basis and it is not expected to bring 50 billion euro, as indicated in the Memorandum but 15 billion euro, i.e. 1/3, between 2013 and 2015. Finally, there is the likelihood of OSI, Official Sector Involvement, i.e. a future haircut of the debt of the official sector, held by European countries. In this respect, a possible reduction would contribute more to the contraction of the ratio of debt to GDP. In conclusion, these are the prerequisites and conditions under which, if the Greek economy developed as expected, servicing the Greek debt in 2020 would be possible. All these things put together form a framework for negotiations, for we Greeks, to try to achieve debt sustainability.
Which of these prerequisites are most probable in your personal opinion?
I would say that the issue of growth is purely an internal matter for the country. And how we couldachieve higher rates of growth depends on the politics of our country and to some extent, on the course of the general economic situation in Europe and the world, which, as you know, is not positive and does not promise a bright future in the coming years. A recession in Europe is envisaged, which means that international demand is not expected to be high. So, in addition to the condition for development, in addition to the condition for recovery of public finances - because the budget should not continue to generate deficits, we should move to primary surpluses. In addition to these two conditions, I do not find the reduction of interest rate unachievable, because it is a matter subject to negotiations, an issue that could easily be placed on the table of talks with our creditors and could eventually become a reality. Second, with regard to privatization, we believe that the amount of 15 billion euro is reasonable; it is not excessive and can be achieved. Third, we think that it might be more difficult and it would require negotiations at European level in order for the debt of banks, recapitalization of banks to go through ESM - ESFP. Something similar is expected to happen in Spain and then, Greece would not be an exception and it would want to be included in the rule. Therefore, something like this is possible but negotiations are necessary to make it happen. And of course, the rescheduling of fiscal consolidation, which we did not mention. Personally, I think it is almost certain that it would be allowed. Remember that we are now talking about the 2013 budget, which must take into account all deviations from the targets in 2012. Therefore, the objectives cannot be achieved in 2012 and they will be transferred to the next period. Anyway, the extension of the programme is something that is being discussed and I think it is achievable. What would be extremely difficult, of course, is OSI, because it means a new round of negotiations to reduce the debt by haircutting. It is something that will have many opponents in Europe and unfortunately, there is no way to know now whether a similar proposal would be approved. However, I believe that it is worthwhile one trying it, to see if it's possible.
Will there be consequences from OSI for the country or will the effect only be positive? We remember that things were not so simple with the PSI. There was a debt haircut but there were problems for banks, insurance funds.
Yes, you're right. We are actually talking about cutting the portfolio of those holding Greek debt. In the case of OSI, we are talking about the official sector, not about the private sector, which means that there will certainly be implications for the public finances of countries holding a Greek debt, which would see the value of this debt melting in their portfolios. It would allow the Greek economy to take a deep breath having in mind that the official sector holds a debt of over 50 billion euro. Therefore, as regards the Greek economy, the effects would be very positive and if we talk about the countries holding the debt, they would have to take a smaller "harvest," if you like, of the Greek debt in their portfolios.
You said that growth is Greece’s internal problem. Economics gives a very clear solution, a recipe for how to achieve growth in the economy - lower interest rates, lower taxes, foreign investment and market liberalization. Why cannot this formula be applied in Greece?
You are quite right and this is precisely the question. Indeed, economics provides the means by which growth can come, but do not forget that in the case of Greece, all economic theories collapsed after 2009. There is no economic theory that is able to accurately predict what exactly is going on here. Consider that even the estimates of international organizations, the International Monetary Fund, the European Commission, and the European Central Bank proved incorrect and were a resounding failure. Remember that the recession they had forecasted for this year was in the range of 4.5%, which was then corrected to 5%, 5.2%, and now, we all accept more or less grosso modo that the recession would be 6% to 7%. Therefore, an element of growth, that is to say the rate at which the economy will grow, has failed so far to achieve those rates that would change the economic climate. That is to say low interest rates. Unfortunately, in periods when there is no liquidity, as currently money is very expensive in Greece. Take a look, for example, at the interest rates on loans - consumer, housing, corporate. They are still very high. And this is because there is a shortage of liquidity, of fresh money. I would like to open a small parenthesis to say that precisely for this reason it is extremely important whether we will get the next tranche of 31.5 billion euro, which will allow the banks and the market in general to take a breath.
Thirdly, one of the big questions that even our international creditors have failed to explain so far is the issue of inflation. While inflation would be expected to decline rapidly in times of recession, we see that the opposite is happening in Greece. Prices have not fallen as our creditors would expect and instead deflation, there is a slight, of course, low inflation of around 1.3% -1.5% -1.7%. Therefore, this marks a moment of failure, the fact that we have not been able to predict with precision.
Fourthly, we have the external environment. Currently, the external environment, the international demand is also recording a downward trend. A negative growth is expected in Europe, which means that it would be much more difficult to secure foreign demand and therefore, foreign direct investment.
Finally, the main factor for me is the uncertainty factor when all these reasons form a framework of uncertainty and no one can be sure whether there is stability in a country. In this case, investment cannot progress, unemployment cannot fall and the growth machine cannot start operating. Therefore, economic theory does indeed show us the reasons, but in the particular case of Greece, one should see for himself the optimal mix of policy measures that would bring growth.
Of course, but Greece has to start somewhere, do something; how do you see the solution?
I'm glad you asked that question because it is what we call "the million dollar question". No one can know exactly how things will develop, because there is the political factor in the country, do not forget that. No one should ignore it, even when economic analyses are being made. I would say that Greece must take the following steps.
First, it should take measures to recover its public finances. It is no good for the economy and the budget in particular to continuously produce primary deficits. At some point, we must begin to spend less than what we collect as revenues. We believe that the 2012 budget will end with a small primary deficit of around 1-1.5%, which means 2 to 3 billion euro. So, the first step is to begin to create primary surpluses. At the same time, the primary surpluses will help to reduce the debt. This is the first point - the stabilization of public finances.
The second direction that we must follow along with the first one is to stimulate growth. I hear that talks about improving the investment law are being held, which is very positive. If we take the right direction - free zones for trade or deals, incentives for public-private partnerships, a more aggressive liberalization of market forces if you will, utilization of state property that has not been utilized, an aggressive privatization programme for the privatization of some key public enterprises, not of all of them, naturally.
The steps taken to liberalize the labour market have had their effect on economic performance. We should immediately proceed to an active employment policy - there are 1.3 million unemployed. Unemployment has reached an alarminly high level and it is threatening to undermine the efforts of the government. It is also threatening social cohesion, because at such times, people begin to feel a growing pessimism about the next day, and the country cannot recover and move forward in this way.
There are some actions with set purposes, some suggestions from us on how to support growth, but I think we have to clarify at this point whether the track along which we are moving is the track that could lead us to the path of growth and ensure the viability of debt.
How much time does Greece have before the situation related to the debt gets out of control?
No one can know for sure, but it is quite clear bearing in mind the course of things. We are in the middle of September, Greece must submit a viable cost reduction programme worth 11.5 billion euro or about 5.5% of GDP, so that the total government's cost of 88 billion euro falls to 77 billion. Let me remind you that 77 billion euro was the cost in the Greek budget for 2003 or 2004 if I'm not mistaken. Therefore, we need to reach those levels. This is the first step.
The second step is to negotiate with the creditors that these measures are acceptable and can be applied. The third step is that a revised medium-term fiscal strategy until 2016 should be prepared, which will include the targets set for 2013, 2014, 2015 and 2016. The budget for 2013 must be prepared, which must include what has been planned in the medium term. Most importantly, the tranche amounting to 31 billion euro will have to be secured. Part of it, a large part of it, will be for the recapitalization of banks and the state will use the rest to repay some of its debts to the private sector or to support the budget.
These are the basic steps. Without them, I think it will be very difficult for Greece to move forward. The tranche of 31 billion euro is necessary and if we have fulfilled our obligations, we must discuss with our European partners whether it would be possible and achievable to look for ways to make the Greek debt serviceable. If these steps are performed steadily, carefully, systematically, we might be able to ensure that Greece would not reach the point at which the crisis could no longer be resolved.
This is largely a matter of European Union policy; it is not exclusively a problem of Greece. It depends on how our European partners will support us in this process. Therefore, to answer your question, no one can be sure how close or how far away this day could be. I can merely say that if the conditions we have just discussed are not met, this day will be very close, whereas if they are implemented, it may never come.
What would the so-called GREXIT mean for the Greek debt?
GREXIT is a term that describes the exit of Greece from the euro zone. A Greek exit from the euro zone, although theoretical, cannot be excluded and it is an eventuality that would have negative consequences for both sides. For the Greek side, which would leave the European family, but for the very European family itself as well. Do not forget that the European Union and the euro zone in particular are interconnected vessels - what happens in one part of the Union spreads throughout the European Union. Therefore, a possible, a hypothetical, if you will, exit of Greece from the euro zone would cause many problems for everyone.
First, after Greece leaves the euro zone it would have to return to its own currency, to a currency that it would have to use in its transactions. As you can see, being an economy with collapsed production structures and without the production base we had in the past it would be very difficult, if not impossible, to compete with international products and services. Therefore, in this case, the currency that would appear after the euro would have to compete successfully with other currencies in international markets. And it could happen only through currency devaluation.
But we should bear in mind that we are in the process of internal devaluation as a country, due to the reduction of salaries in the range of 25% to 27% within 2-3 years. Another devaluation of the currency would have very serious social consequences. To put it simply, the money available to a person would not be enough to make a living. It would be enough only for the first 2-3 days after receiving the remuneration. After that, other scenarios to make a living would be necessary. So, the exit of a state from the euro zone would open "Pandora's box" because it would start to "unravel Europe's sweater," according to some people. Other European countries would not remain unaffected either. The single currency, the euro, is likely to be under pressure and would be seriously undermined if a state left it. Huge accounting problems would have accrued - how to transfer all accounts and how to convert them into the new currency.
Our debts would be in a foreign currency, a third stronger currency, which means that the value of our debt, especially if devalued, would further increase and servicing it would become even more difficult. I think this scenario is catastrophic. I do not think that it is a scenario that could offer the solution to our country or to Europe in general. I also think that the consequences of such a development would reach the other side of the world, America and Asia, as the local markets there are directly related to the European ones. Therefore, I do not think this is a scenario that would have a positive aspect, as we understand it. On the contrary, it would have serious negative consequences for the economy - the Greek, European, but for the world economy too.
How do you see the problem with the debt crisis at European level?
The truth is that Europe is like a very large vessel and as such, it is very difficult for it to move quickly and flexibly. It's like a captain who wants to make a manoeuvre with the ship and who must realize that it takes a long time and a lot of space. Unfortunately, Europe has neither the time nor space at present. Europe was relatively slow in its response to the challenges of the recession and the crisis in general. Not only in the case of Greece, but also with other countries - Portugal, Spain, Ireland and perhaps other countries with problems that are likely to emerge later. It was rather timid in its decisions; the steps taken were small, careful and thoughtful. But it failed to provide an effective response to the debt crisis in Europe and Greece. I fear that the next summit on 18 to 19 October will have to take very bold decisions on how to move forward together as united Europe, because it has become clear that many of the decisions have been postponed to the future, and things have been left adrift.
I believe that the involvement of Germany and its position on all these issues is very important and I would like to make a remark here. Germany is facing a serious dilemma. On the one hand, being the first economic power in Europe, it is called to play a leading role in Europe's future - something the Germans want I guess, especially if we talk about economic leadership in the club of euro zone countries. But the strange thing is, on the other hand, that the Germans do not want to assume the responsibility typical for such a leader. This responsibility means potentially greater contribution from their side and in the permanent European Stability Mechanism ESM, possibly in the decisions concerning debt financing too. So, we see this contradiction - on the one hand, they are called to play a leading role which they want, but they do not want it to involve the respective responsibilities of the leader. These issues need to be solved in Germany. And there are other countries in its shadow - Austria, Ireland, countries that generally support the policy of fiscal austerity and discipline.
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