Why the third Greek bailout is likely to fail

Published by MNI Euro Insight

It looks like it’s all being sorted: Eurozone parliaments have grudgingly agreed to a third Greek bailout allowing the eurozone’s bailout fund ESM to lend 86 billion euro over three years to Greece, while early elections should consolidate the more moderate part of Syriza in power. Hereunder I take  a closer look at the assumptions underlying the third bailout, explaining why Greece’s debt situation is unlikely to be “sustainable”.

Given that trust in the European Commission is limited at best, the more “hawkish” Eurozone countries are keen to have the – presumably more “hawkish” - IMF involved, despite the fact that the latter leaves no occasion unused to tell Eurozone countries to take losses on their lending to Greece, something it doesn’t even want to contemplate with regards to its own lending to Greece.

A key condition for the IMF to be involved and lend some more cash to Greece is that Greek debt is “sustainable”. It already agreed with Eurozone countries to basically ignore that the country’s debt is heading to reach 200% to GDP in 2016. Instead it will look at whether the percentage of GDP which Greece devotes to “debt service” exceeds 15%, having agreed that above this point debt service would be unsustainable. Eurogroup Chairman Jeroen Dijsselbloem has stated that even according to the most pessimistic Eurozone predictions for future Greek growth, Greece’s debt service still wouldn’t exceed 12% and would thus be “sustainable”, at least “in the 2020‐2030 period” . The only thing is that according to him “the remaining difference is that the IMF’s worst-case scenario is more pessimistic than ours.” With Open Europe, we expect that the IMF may be convinced by extending maturities – from just over 30 years now to around 50 years – combined with an extended grace period in which Greece doesn’t have to pay back debt yet – up from ten years now to between 20 and 30 years. The interest rate Greece now pays is lower even than the one carried by Portugal, Italy, Ireland and Spain and can hardly be cut much lower.

This tinkering to keep the IMF on board may perhaps make sure that given the assumptions of Eurozone countries, Greek “debt service” costs remain under 15% of Greek GDP also after 2030. Still it’s of course questionable whether it’s possible to predict GDP growth figures so far ahead. Even more questionable, and the fundamental problem here, are the assumptions.

The Eurozone estimates in its “debt sustainability analysis” that in the most pessimistic scenario, Greece’s economy would shrink 0.75% this year, would remain at 0% growth in 2016 and at 1.25% in 2017 and 3% in 2018%. Also the IMF doesn’t seem much more keen to predict negative growth data any more than Soviet bureaucrats were. As recently as April, months after the Syriza-victory had produced a deep stand-off with Greece’s creditors, it predicted that Greece would be the fasted growing country in Europe, although in July it said that the crisis would take “a heavier toll” than previously expected on economic activity in Greece. This all reminds of how its predictions of Greek GDP growth, really since the crisis erupted, consistently turned out to be false.

On the other hand, estimates by private institutions put Greek growth for this year and the next few years at a much more negative level than the eurozone’s “most pessimistic” estimate, with for example Standard & Poor's predicting at the end of July that Greece’s GDP would shrink 3% in 2015. In April, S&P thought Greek GDP would be shrinking 1.5% in 2015 whereas the IMF still predicted growth of 2.5% for Greece this year. If this gap can be of any guidance of the incompetence of public sector institutions, the growth predictions may turn out to be false once again and the annual “debt service” may easily surpass 15% of Greece’s shrunken GDP.

There are more factors indicating Greek growth may not take up: there are lots of reports of Greek companies relocating or considering to do so. Some 60.000 have requested moving their headquarters to Bulgaria, while ship owners may move at least part of their operations to Cyprus due to increased taxation. Not exactly a factor which may boost Greek growth.

Currently, the EU Commission estimates that the Greek “fiscal gap” amounts to 1.25% of GDP, or around 3 billion euro. It looks like the idea is to largely finance this by tax hikes. The “memorandum of understanding” - the instruction list imposed by creditors – requires that the unpopular real estate tax ENFIA, to be paid at the end of October, “should raise €2.65 billion revenues in 2015”. Spending cuts this year look minimal, although defense spending will still be cut by 100 million euro before the 1^st of January. Other tax hikes include an increase of the corporate tax rate from 26 to 29%, increasing sales tax on processed food and restaurants to 23%, abolishing VAT discounts for Greek islands, extra luxury taxes on big cars, boats and swimming pools, a new tax on television advertisements,  “tonnage taxes” which will hit the shipping industry, higher income taxes on – lightly taxed – farmers, higher taxes on insurance premiums and a higher “solidarity tax” for all income brackets. To be fair, the next few years will witness more spending cuts, like 400 million euro in military spending next year, but it’s puzzling how anyone can believe releasing an avalanche of tax hikes on an economy already suffering from capital controls will do anything to boost growth.

Furthermore, one doesn’t need to have paranormal abilities to be able to predict that tax hikes will also lead to a greater informal economy, thereby further shrinking Greece’s official GDP which is supposed to carry the annual debt service cost of which EU institutions think it’s sustainable and won’t exceed 12% even in the most pessimistic scenario.

Then there is the question mark how much Greek privatisation efforts may raise. It’s widely assumed these will fail to bring in the 50 billion euro which creditors are expecting. During the previous “programme”, EU institutions estimated that selling off Greece’s state owned real estate may raise “anything above some €20bn”, but this failed spectacularly. In 2011, Greece’s creditors wanted Greece to raise 50 billion euros as well by selling state assets. Since then, however, Greece only managed to raise 3.2 billion euros: 94 percent below the target. The failure to do so was due to obstruction by powerful and privileged trade unions and because it was hard to value certain assets, like Greece’s islands, while there was little demand for things like sport infrastructure or government airplanes.

Still, privatisation is a great idea. It can work in Greece, as proven by the privatisation of Piraeus Container Terminal’s strong performance since it was taken over by China’s COSCO Pacific. Still one should do it in order to make the economy more competitive and not in order to raise a lot of money.

It’s unfortunate that the Greek government will use some of the proceeds from privatisation to recapitalize some of the country’s zombie banks. Essentially, more than half of the capital of Greek banks are claims on the shaky Greek state, which itself owns stakes in Greek banks. It would be better to first unwind these zombie banks, whereby shareholders and bondholders suffer losses, and then restructure and completely privatise them.

I haven’t mentioned the “structural reforms to enhance competitiveness and growth”, which are laudable, but unlikely to lead to a quick turnaround in growth, given how deep-rooted Greece’s structural challenges are. The fate of the unstable Greek bank system and its debt service burden are hanging like the Damocles over everything else. Angela Merkel had the opportunity to test a different recipe on 12 July, but she chose to kick the can down the road. One last time?