One day later in Greece: The more things change, the more they remain same

Greece has defaulted on the payment of 1.6 billion euros that it had to make to the International Monetary Fund (IMF) by the end of the day yesterday (i.e. June 30, 2015) This is the first instance of a developed country defaulting on a payment that it owed to the IMF.

The question now is, what happens next? A referendum scheduled on Sunday is asking Greek voters to decide whether they are ready to bear more austerity measures in order to stay in the Eurozone. Countries which use the euro as their currency are together referred to as the Eurozone.

Nevertheless, the Greek deputy prime minister Yannis Dragasakis said on Greek television yesterday that the government had decided on a referendum and “and it can make a decision on something else.”

This is widely being seen as an effort to placate Germany and the institutions like the European Central Bank (ECB), which seem to have hardened their position on Greece in the recent past.

A referendum could go either way. And if Greece decides to leave the Eurozone, it can start a spiral in which other bigger economies like Spain, Italy and Portugal, might do the same, putting the entire idea of the euro and the United States of Europe in jeopardy. Interestingly, there is no step by step procedure for a country to leave the Eurozone.

Reports appearing in the media suggest that Greece is seeking a third bailout. The first bailout came in 2010. The country was on the verge of defaulting money that it owed to French and German private banks. The IMF, along with the ECB and the European Commission, bailed it out. Much of this money was passed on to the German and French banks.

As Anil Kashyap of the University of Chicago writes: “Much of the government debt was owed to banks outside of Greece, with the largest amounts in France and Germany. So if Greece had stopped paying, the French and German banks would have suffered substantial losses.” Hence, what was passed on as a rescue of Greece, was essentially a deal to rescue the French and German banks which had lent heavily to Greece.

This money came with a lot of terms and conditions and the Greek government had to put austerity measures in place. The hope was that with these measures the Greek government would start running a budget surplus and that money could be used to repay the money that had been borrowed from the IMF and other institutions like the European Commission and the ECB, which are together referred as the troika. Budget surplus is a situation where the earnings of a government are greater than its expenditure.

There was another bailout in 2012. This happened after those in decision making positions started to understand that the 2010 bailout wouldn’t be enough, given that the recession in Greece had continued. The IMF lent more money to Greece, on the same terms and conditions that it had in 2010.

As Kashyap writes: “Once again, the cornerstones of the plan continued to be steps to make tax collection more efficient, to reduce spending promises, and to undertake reforms to encourage hiring and business expansion that would support growth. It was not clear why this plan would be more successful than the first one.”

The country now owes close to 240 billion euros to the troika. The austerity measures have had a highly negative impact on the Greek economy. As Nobel Prize winning economist Joseph Stiglitz recently wrote: “Of course, the economics behind the programme that the “troika” foisted on Greece five years ago has been abysmal resulting in a 25% decline in the country’s GDP. I can think of no depression, ever, that has been so deliberate and had such catastrophic consequences: Greece’s rate of youth unemployment, for example, now exceeds 60%.”

Other than the austerity measures the Greek government was also supposed to push through economic reforms that would revive economic growth. But that bit never happened. Further, in a recessionary environment with the government cutting down on spending, the economy contracted further. This essentially led to a situation where the total amount of debt with respect to the Greek gross domestic product (GDP) went up instead of going down. Currently the total debt to GDP ratio of Greece stands at a whopping 175%. And this number is likely to go up further in the days to come. The Guardian newspaper reports that even if Greece were to accept the terms and conditions set by the troika for a third bailout, it is not going to come out of trouble anytime soon. The troika wants Greece to achieve a primary budget surplus, which does not take interest payments on debt into account, of 3.5% of GDP by 2018.

Estimates suggest that by 2030, the Greek debt to GDP ratio would still be at 118% of its GDP. “That is well above the 110% the IMF regards as sustainable given Greece’s debt profile, a level set in 2012…Even under the best case scenario, which includes growth of 4% a year for the next five years, Greece’s debt levels will drop to only 124%, by 2022. The best case also anticipates 15 billion euros in proceeds from privatisations, five times the estimate in the most likely scenario,” the newspaper points out. All in all things don’t look good either way for Greece.

Alexis Tsipras since taking over as the prime minister of Greece in January 2015 has asked for outright forgiveness on some of the Greek debt. The trouble is that if anything like this were to take place, other highly indebted countries like Italy, Spain, Portugal and Ireland would want to be treated along similar lines. Hence, a bad precedent would be set.

As Kashyap puts it: “The money needed to save Greece could easily be found. Greece is a small economy, so even though their debt is large when judged relative to Greece’s economy, it is small relative to the overall capacity in Europe. In contrast, the money needed to forgive debt in the other countries, especially Italy and Spain, is not affordable for Germany (and all the other Northern European countries that would have to foot the bill).” To conclude, we haven’t seen the last of this Greek tragedy as yet. The sequels will continue to come. And every time the effort will be made to postpone the inevitable. Stay tuned!

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)