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Special Report

ESG: The metrics jigsaw


Greek crisis appears defused

A renewed Greek crisis looks unlikely after the recent debt relief deal with creditors. Ayşe Ferliel Barounos reports

At a glance

• Greece has finally reached agreement on a roadmap for debt relief with most of its creditors.
• The International Monetary Fund has not yet agreed to participate but it is expected to do so.
• Some measures, such as caps and deferrals on interest rates, will not be considered until 2018.
• Some analysts are sceptical about the deal’s ability to resolve Greece’s debt plight.

Greece and its creditors have agreed on a road map for debt relief after a long struggle to get the country’s finances under control. The eight years since the outbreak of the global financial crisis have been marked by three bailout deals, six years of austerity and concerns over Greece’s future in the euro-zone.

Sluggish progress in implementing reforms already agreed and disagreements on the legislation of a series of new measures had sparked talks of a renewed Greek crisis. This had revived fears of a so-called ‘Grexit’, the country’s exit from the common currency, even as Britain got ready to vote on its European Union (EU) membership. However, euro-zone finance ministers and the International Monetary Fund (IMF) eventually sealed a deal in late May that cleared the way for fresh loans for Greece. It also set out how the country could get debt relief in the future, based on short, medium and long-term measures.

After months of frenzied negotiations, the country’s creditors agreed to complete the first review of progress on Greece’s financial assistance programme of up to €86bn. The move raised hopes that the country could avoid another debt drama this summer. The bailout review was originally scheduled for completion at the end of last year. Its successful completion has been a prerequisite for Greece to receive further installments as part of its latest rescue and for addressing the contentious issue of debt relief.

Once the deal was sealed the Eurogroup of euro-zone finance ministers issued a statement saying Greece will get €10.3bn – a second tranche of its loan package, “starting with a first disbursement in June (€7.5bn) to cover debt servicing needs and to allow a clearance of an initial part of arrears as a means to support the real economy”. It also said subsequent disbursements would be made after the summer.

The ratio of government debt to gross domestic product (GDP) stood at 176.9% in Greece at the end of 2015, down from 180.1% in 2014. This compared with 90.7% in the euro-zone as a whole in 2015 and 92% in 2014. Reducing Greece’s mountain of public debt had been a key condition by the IMF in providing further financial support to Greece. The IMF had co-financed Greece’s first two bailouts but has, so far, refused to contribute to the third loan package, claiming that the country’s debt is not sustainable. Meanwhile, some euro-zone members, Germany in particular, had insisted on IMF participation for additional loans. It still remains to be seen if the fund will end up providing more loans.

Greece needs billions of euros of fresh bailout funds to avoid bankruptcy and to cover large debt payments due in June and July – it has to make more than €3bn in debt payments in July. When euro-zone finance ministers met on 9 May, they “welcomed” the Greek government’s move to pass crucial income tax and pension overhauls, but also demanded a “contingency mechanism” to ensure that a package of measures “would be automatically implemented as soon as there is objective evidence of a failure to meet the annual primary surplus targets in the programme”.

Following its meeting on 24 May – which took place just days after the Greek Parliament approved another round of spending cuts and tax increases – the Eurogroup said Greece and the European institutions had reached an agreement on the contingency fiscal mechanism in line with its statement of 9 May, “in particular as regards the possible adoption of permanent structural measures, including revenue measures, to be agreed with the institutions”.

In contrast to the European institutions overseeing the bailout – the European Commission, the European Stability Mechanism (ESM) and the European Central Bank (ECB) – IMF officials do not seem to believe that Athens would be able to generate a 3.5% primary surplus in 2018. This target was agreed last year, based on several measures that involve pensions, taxes and non-performing loans (NPLs) in the banking sector. A government is considered to have achieved a primary surplus when its current revenue is higher than its current spending (stripping out interest on debt).

At an earlier meeting (on 9 May), the euro-zone finance ministers had set out a path to debt relief – excluding “nominal haircuts” – and Eurogroup President Jeroen Dijsselbloem had emphasised that the European creditors would “look at possibilities of re-profiling and if necessary possible additional measures, looking at maturities and grace periods as outlined in the agreement last summer”. The deal announced in late May focused on a package of debt measures which will be phased in progressively. As part of the measures, Greece will be able to gain a short-term re-profiling of its loans. However, other steps such as caps and deferrals on interest rates and the channelling back to Athens of profits from Greek government bonds held by euro-zone central banks, will be considered only after the end of the current bailout (mid-2018).

Analysts are divided on whether or not Greece’s crisis could go on indefinitely without debt reduction. Some suggest that debt relief could give the country the boost it needs to escape from the vicious circle of austerity and recession which has devastated its economy. Others argue that Greece should change its economic model and implement deep structural reforms as opposed to relying on hiking already high taxes or cutting excessively discretionary spending. Another group – with the IMF leading the pack – argues that a combination of further reforms and debt restructuring should be the way forward. The IMF had previously insisted that “specific measures, debt restructuring, and financing must now be discussed contemporaneously” as pointed out recently by its managing director, Christine Lagarde. However, after intense negotiations, the fund had to accept that the most important debt-relief measures would not be enacted until 2018.

The IMF management is expected to recommend to its executive board that it provide further financial assistance to Greece. This move will be contingent on a new debt sustainability analysis and an assessment of the relief measures mentioned in the May announcement.

Analysts, political and economic alike, had doubted that a comprehensive and lasting solution to Greece’s debt overhang could be achieved soon. But most had also believed that the likelihood of another Greek crisis that could have wider ramifications outside the country was relatively low. “A Greek sovereign debt default and exit from the currency union no longer is as huge a contagion threat for other euro-zone countries as it was in 2010-12,” said Michael Heise, chief economist of Allianz.

His views were echoed by Douglas Renwick, Fitch Ratings’ head of Western European Sovereigns, who noted that the rest of Europe is “a lot more insulated from developments in Greece” than it was in 2010. “This is helped, of course, by the fact that the private sector in Europe now has very little direct exposure to Greece,” Renwick added. Heise noted that today more than 80% of Greek debt is held by sovereign creditors whereas in 2010-12 it was mainly held by private investors.

Indeed, when the then newly elected centre-left PASOK government revealed in October 2009 that Greece’s public deficit was much larger than previously reported, the ensuing Greek fiscal crisis “acted as a detonator” in two ways, according to Stefano Micossi, a professor at the College of Europe and Director General of Assonime, Association of the Italian joint stock companies.

In a VoxEU eBook (The Eurozone Crisis: A Consensus View of the Causes and a Few Possible Solutions), Micossi argued that in 2010-11 the euro-zone was hit by a classical balance of payments crisis and the ‘sudden stop’ of cross-border capital flows to peripheral countries. He said that on the one hand, the Greek crisis “alerted the authorities and public opinions in Germany and the other ‘core’ countries to the possibility of large (and hidden) violations of the common fiscal rules.” He added that “on the other hand, it awakened investors in financial markets to the risk of a sovereign default in a system where the provision of liquidity to ensure the orderly rollover of distressed sovereigns is not guaranteed”.

As investor confidence eroded, the yields on Greek sovereign bonds, which correspond to the cost of borrowing money, rose to unsustainable levels. The situation worsened to the point where the country was no longer able to refinance its borrowing, and it asked for help from its European partners and the IMF. Contagion to other peripheral countries was fuelled by the Deuville pact of October 2010 – between German Chancellor Angela Merkel and then French President Nicolas Sarkozy – which called for private investors holding bonds in insolvent euro-zone nations to shoulder losses on them. This move opened the way to a large write-down of Greek debt held by private investors, mainly banks, on the occasion of the second bailout agreement (which was signed in 2012).

“The flight of private capital brought to their knees one after the other the sovereign bond markets and the banking systems of Greece, Ireland, Portugal, Spain, Italy, and eventually Cyprus, setting in motion a disastrous doom loop between sovereign and bank crises,” Micossi added.

However, things have changed significantly since then, as pointed out by Heise, who said “the European crisis mechanisms have been reinforced” and institutional reforms – such as the introduction of the ESM and the European banking union with joint banking supervision – have been undertaken. He also added that countries most at risk of contagion were much better placed than they were in 2012, having reduced dangerous imbalances and implemented important structural reforms. Both Heise and Renwick argued that the large-scale actual (and potential) interventions by the ECB also helped the euro-zone.

The deal reached in May raised hopes that another Greek crisis could be avoided in the foreseeable future. This was not least because Greece and its creditors had strong incentives to bridge their differences, particularly at a time when the country’s financial woes have also been intensified by the arrival of thousands of refugees. Some analysts had, in fact, argued that Greece’s bailout review should be wrapped up before the UK’s June referendum on EU membership.

Although the European creditors presented the May deal as a “breakthrough”, some analysts were sceptical. In a research note, Wolfango Piccoli, co-president of Teneo Intelligence, said “while this is a move in the right direction from the Greek perspective, the roadmap remains vague and the eventual meaningful debt relief measures distant”. Similarly, Fitch Ratings said “with little debt relief offered upfront, the Greek government may find it progressively more difficult to continue with politically controversial measures required to meet ambitious programme commitments. Implementation risk therefore remains high”.

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