Opinion

Greece and the euro area need a deal within days, not months

International press informs us that the Greek government believes it has weeks or perhaps months to negotiate a new deal with its creditors. The basic idea of the new Greek finance minister Yanis Varoufakis is that Greece remains in the Eurozone even once the financial assistance agreement has expired end of February thanks to a European Central Bank propping up the weak Greek banking system. This, however, will hardly be possible for a number of reasons.

By: Date: February 2, 2015 Topic: Macroeconomic policy

International press informs us that the Greek government believes it has weeks or perhaps months to negotiate a new deal with its creditorsThe basic idea of the new Greek finance minister Yanis Varoufakis is that Greece remains in the Eurozone even once the financial assistance agreement has expired end of February thanks to a European Central Bank propping up the weak Greek banking system. This, however, will hardly be possible for a number of reasons.

(a)    Already now, Greek government debt should become non-eligible as ECB collateral. The Greek finance minister has declared that his country is insolvent. When a finance minister declares the insolvency of his country, then the quality of all the debt he has issued should fall below the relevant thresholds for Emergency Liquidity Assistance as well as standard monetary policy operations. While I do not believe the ECB will be so consequential as to do this immediately, I also cannot believe that it will just continue lending for a long time.

(b)   The ECB’s single supervisory mechanism (SSM) should now raise serious questions about the solvency of Greek banks. Greek banks hold significant amounts of government debt. As a supervisor, it should ask tough questions to find out whether the banks would withstand a default of its government.

(c)    The SSM should also prohibit Greek banks to buy any paper issued by the insolvent Greek government. This means that indirect government funding by issuing short-term T-bills and repo-ing them at the ECB or in the ELA will become impossible.   

In my analysis, the case for insolvency is far less clear. The insolvency of a country depends on whether it is able to pay the interest on its debt. Greece’s interest burden is likely to be as low as 2% of GDP in 2015 according to the calculations of my colleague Zsolt DarvasThis makes the debt burden comparable to France (2.3%) and Germany (1.8%). Of course, one can argue that it is the high future debt cost that weighs currently on the Greek economy. In the assessment of markets, this was however a negligible concern until recently. Only last year, Greece could issue 5-year sovereign debt at interest rates of only 4.95%. Nevertheless, the high debt burden can indeed prove damaging for the Greek economy, especially if nominal growth will be well below the predictions of the official institutions in the next years as it seems likely right now.

By talking about insolvency, the Greek finance minister has raised the funding needs for Greece’s banking system and made government fund raising on capital markets impossible.

The Greek finance minister has therefore posed a difficult challenge to the EU and the IMF. By talking about insolvency, he has raised the funding needs for Greece’s banking system and made government fund raising on capital markets impossible. The recent government decisions have seriously raised doubts about Greece and capital is by now moving out of the country as quickly as possible, putting to a test the limits of ECB’s funding possibilities against dubious collateral. It is therefore clear that the government will have to quickly find an agreement with its creditors if it wants to stay in the euro area. It is also important to highlight that the current uncertainty is bad for the Greek economy. So what could such a deal look like? Here are my essential elements.

1)      Reverse the additional government spending announced last week. When a country is insolvent and increases its spending, it is de facto decreasing its budget constraint at the expense of others. Tsipras has the democratic right to negotiate but he has no democratic legitimacy to spend money from taxpayers in other countries.

The situation in Greece is indeed bad and the euro area should enact solidarity

2)      There should be a Eurogroup meeting (the next meeting is scheduled for 16 Feb, which may be too late) to discuss the Greek situation. Syriza has won an election for a reason. The situation in Greece is indeed bad and the euro area should enact solidarity. For example, additional government spending to alleviate serious problems in the health system could be funded by special and additional EU funds.

3)      The immediate funding needs of Greece need to be discussed and covered. A technical default would undo years of work to regain market access. More worryingly, it would leave the government in a position in which it will be hard to fund all its services and/or it would have to default on its obligations to the IMF, which amount to 7.9 billion for 2015. For the ECB, the repayment amounts to 6.5 billion in July/August 2015.

4)      As regards the debt, it is in the interest of the creditors as well as Greece to achieve a solution in which debt dynamics do not explode, as this would not only undermine the recovery in Greece further but also make the repayment impossible. It is also in mutual interest to have a solution that is robust to different kinds of shocks in order to prevent a repetition of a drama as we currently see it. A sensible solution would be to agree to index the size of the debt burden to a baseline GDP scenario. A decision to adjust the debt burden symmetrically could be taken every 3 years when GDP deviations are clearly visible. This would mean that Greece would have to repay more if GDP performs better and less if GDP performs worse than the baseline. One could also agree on an extension of the maturity and a reduction in the interest rate on the remaining bilateral loans.

5)      Greece will have to commit to fulfil a number of conditions that make the baseline growth scenario achievable.

6)      As regards the Troika, Tsipras would have been well-advised to use it to achieve some of his promises such as finally taxing the rich oligarchs in the country. Yet, it is probably too late to save the Troika in its old form. The ECJ’s General Attorney did cast some doubt on the participation of the ECB in the Troika in case of an OMT programme. One could therefore foresee a new construction, in which the ECB would not be part of the missions. In any case, the ECB will be present in the country as a single supervisor and will have to ask tough questions to the Greek banks.

7)      Finally and in the interest of risk management, the euro area should agree to increase the Juncker plan with national fiscal resources in order to boost aggregate demand in the euro area as a whole. While this will hardly help Greece with its small export sector, it would benefit a number of other countries that are trapped in a low growth scenario. In doing so, the risk of election of radical parties would go down and painful structural adjustment would be made easier.

 Both sides have a strong interest in preventing an exit from the euro area

Overall, it is clear that both sides have a strong interest in preventing an exit from the euro area, which will be unavoidable if an agreement is not reached soon. A cooperative solution is not unachievable but it requires Greece to go to the Eurogroup as a reasonable negotiating partner and it requires the euro area to be ready for some concessions. 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Upcoming Event

Nov
2
14:00

Microchips and Europe's strategic autonomy

Per microchips ad strategic autonomy.

Speakers: Piotr Arak, Alicia García-Herrero, Jay Lewis and Niclas Poitiers Topic: Digital economy and innovation, European governance
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Grégory Claeys and Wolfgang Lemke Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Unboxing the State of the Union 2021

In this Sound of Economics Live episode, Bruegel experts look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

By: The Sound of Economics Topic: Macroeconomic policy Date: September 15, 2021
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: Unboxing the State of the Union 2021

In this Sound of Economics Live episode, we look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

Speakers: Grégory Claeys, Maria Demertzis, Alicia García-Herrero and Giuseppe Porcaro Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 15, 2021
Read article More on this topic More by this author
 

Opinion

EU climate plan should involve taxing pollution, not borders

Climate change and taxes may be some of the only true certainties in life. To protect ourselves better, we should make careful choices on how they interact.

By: Rebecca Christie Topic: Green economy Date: September 6, 2021
Read article More on this topic
 

Blog Post

How have the European Central Bank’s negative rates been passed on?

Negative rate cuts are not that different from ‘standard’ rate cuts. Like them, they reduce banks’ margins, but this effect does not appear to be amplified below 0%.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: Macroeconomic policy Date: July 7, 2021
Read article More on this topic More by this author
 

Blog Post

Inflation!? Germany, the euro area and the European Central Bank

There is concern in Germany about rising prices, but expectations and wage data show no sign of excess pressures; German inflation should exceed 2% to support euro-area rebalancing but is unlikely to do so on sustained basis.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: June 9, 2021
Read article
 

Blog Post

European governance

Emergency Liquidity Assistance: A new lease of life or kiss of death?

Use of Emergency Liquidity Assistance to prop up euro-area banks needs to be more transparent; available evidence suggests its use has not always been within the rules.

By: Francesco Papadia and Leonardo Cadamuro Topic: European governance, Macroeconomic policy Date: May 28, 2021
Read article More by this author
 

Opinion

European governance

Europe must fix its fiscal rules

The pandemic has shown that the EU’s spending framework reflects an outdated economic orthodoxy.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: May 27, 2021
Read article More by this author
 

Podcast

Podcast

A stronger euro comes with more responsibility

What does strategic sovereignty mean to and for Europe?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: May 19, 2021
Load more posts