Grexit looms: Greece should not have been part of Eurozone in first place

In his wonderful book How to Speak Money British novelist John Lanchester defines Grexit as “the hypothetical exit of Greece from the Eurozone”. This hypothetical situation may be soon upon us. The Eurozone consists of 19 European countries which use euro as their currency. By tomorrow (i.e. 30 June 2015) Greece needs to make a payment of €1.6 billion (or $1.1 billion) to the International Monetary Fund (IMF). Chances are the country may default. It does not have any money to repay loans. [caption id=“attachment_548083” align=“alignleft” width=“380”] Worried Greek citizens. AFP.[/caption] If Greece does not repay the IMF by tomorrow it will be declared to be in a default. It may also have to leave the Eurozone and the euro. This possibility has spooked the financial markets all over the world. The BSE Sensex fell around 600 points from its previous close (on Monday) but managed to recover and close the day around 167 points or 0.6 percent below its previous close. To prevent the flight of money from Greece, the Athens stock market did not open on Monday. The BBC reports that the Greek banks are shut and are expected to remain shut until 7 July 2015. Over the weekend Greek citizens were queuing up in front of ATMs to withdraw money. All in all, the way things stand they are definitely not looking good and Greece seems headed towards a bigger financial crisis. The country owes around €240 billion to the European Commission, the European Central Bank (ECB) and the IMF, together referred to as the troika. This money needs to be repaid. As I had mentioned in my previous column on Greece which appeared on 23 June 2015: “Every time the troika lends money it demands more austerity measures from Greece. The idea is to ensure that the Greek budget enters into a positive territory so that the country is finally able to start repaying the debt it owes, instead of borrowing more to repay what it owes. The troika wants the Greek government to run a surplus i.e. its revenues should be more than its expenditure.” In the normal scheme of things, a country can print money to repay its debt. But Greece cannot do that simply because the power to print euros is with the European Central Bank and not with the individual central banks of countries that constitute the Eurozone. Another option is to devalue the currency to make exports competitive, earn through that and then repay the debt. Greece cannot do this as well because it is a part of a common currency area. So all this leaves Greece with very few options. In fact, the troubles of Greece as well as the euro may have started at the very beginning. When the concept of euro was first initiated, for countries to use the euro as their currency several conditions needed to be met. The fiscal deficit of the country should not have been higher than 3 percent of its gross domestic product (GDP). Fiscal deficit is the difference between what a country earns and what it spends. At the same time the total public debt (the total government debt minus the government debt held by the various arms of the government) shouldn’t have been more than 60 percent of the GDP. The exchange rates of their currencies also needed to move in a certain range fixed by the European monetary system. But these rules were not hard and fast. The Council of the European Union could decide to admit countries which did not fulfil these criteria and in fact it did. It allowed countries like Italy and Belgium to use the euro as their currency even though there public debt was greater than 60 percent of their GDP. In fact, most countries tried to fulfil the criteria only in letter and not really in spirit. Some fulfilled the criteria using accounting gimmicks where they spread expenditure over a longer period of time. Some others generated one time revenues to reduce their fiscal deficit. Several countries managed to fulfil the criteria only for 1997, the year in which it was decided which countries of the EU could use the euro as their currency. Greece was helped by the investment bank Goldman Sachs to hide its debt through a series of deals, which helped Greece hide its true level of debt. As Neil Irwin writes in The Alchemists—Inside the Secret World of Central Bankers: “Instead of fixing their fundamentals of their economy, the Greeks were cooking their books. One widely covered instance was a series of currency swaps arranged with the assistance of Goldman Sachs in early 2000s that essentially allowed the Greek government to borrow money without issuing debt that would shop in official statistics.” There were other things that the Greeks did so as to ensure that fulfilled the terms of using euro as their currency. As Irwin writes: “Less widely known were such tricks as underreporting how much the nation was spending on its military (a particularly large expense given the perennially tense relations with Turkey) and the failure to account for debts owed to hospitals…The government fudged its numbers by selling off long-term assets—the rights to future airport fees, for example—in order to fund immediate spending.” In fact, Greece continued to underreport its fiscal deficit over the years and it was left to the then finance minister George Papaconstantinou to discover the real level of the Greek fiscal deficit in October 2009. George Provopoulos, the governor of the Bank of Greece, the Greek central bank, told Papaconstantinou that the actual fiscal deficit of Greece was 12.5 percent or higher. Irwin details the dealings between the finance minister and the central bank governor of Greece. “Every day, they found new expenses that hadn’t been property accounted for—600 million euros owed to hospitals, for example, with no accurate record of when the expenses had even incurred. Every evening, Papaconstantinou would leave and say, “Okay, guys, is that it?” It never was. “Basically, we were discovering that the Greek government had no budget,” said Papaconstantinou later.” When Papaconstantinou and Provopoulos finally got hold of all the numbers, the actual Greek fiscal deficit for 2009 turned out to be 15.7 percent of the GDP, higher than the estimate put forward by the central bank governor. Hence, Greece never had the fiscal discipline that was required to be a part of a monetary union. Honestly, it is not fair to just blame Greece for what is happening. From the very beginning the conditions which were at the heart of the euro were never really taken seriously. Germany had tried to introduce automatic sanctions which would involve fines on countries which violated these conditions especially deficit overruns but other members of the European Union did not agree to it. In 2003, the Council overruled the sanctions recommended by the Commission of the European Union on Germany and France. The Council watered down the conditions even more in 2005, when Germany couldn’t meet the 3 percent limit on the fiscal deficit for a third time in a row. It defined several situations in which a country could violate the 3 percent limit. This included situations like natural catastrophes, a falling GDP, recessions, pension reforms, public investment, expenditure carried out for innovation and research and so on. The conditions could pretty much justify any and every expenditure a government carried out and thus overrun its fiscal deficit target of 3 percent. The euro thus rested on a shaky foundation which got shakier over a period of time. Once the likes of Germany and France had stopped following the rules on which the foundations of euro rested, it was hardly possible to expect countries like Greece to follow the rules. (Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)