It’s Not About Greece Any More
By Peter Boone and Simon Johnson
The Baseline Scenario.com
The Greek “rescue” package announced last weekend is dramatic, unprecedented, and far from enough to stabilize the eurozone.
The Greek government and the European Union (EU) leadership, prodded by the International Monetary Fund (IMF), are finally becoming realistic about the dire economic situation in Greece. They have abandoned previous rounds of optimistic forecasts and have now admitted to a profoundly worse situation. This new program calls for a total of 11% of GDP in terms of “fiscal adjustments” (i.e., reduction in the budget deficit; now meaning government spending cuts mostly) in 2010, 4.3% in 2011, and 2% in 2012 and 2013. The total debt to GDP ratio peaks at 149% in 2012-13 before starting a gentle glide path back down to sanity.
This new program is honest enough to show why it is unlikely to succeed. Daniel Gros, an eminent economist on euro zone issues based in Brussels, has argued that for each 1% of GDP decline in Greek government spending, total demand in the country falls by 2.5% of GDP. If the government reduces spending by 15% of GDP – the initial shock to demand could be well over 30% of GDP. Obviously this simple rule does not work with such large numbers, but it illustrates that Greece is likely to experience a very sharp recession – and there is substantial uncertainty around how bad the economy will get. The program announced last weekend assumes Greek GDP falls by 4% this year, then by another 2.6% in 2011, before recovering to positive growth in 2012 and beyond.
Such figures seem extremely optimistic, particularly in face of the civil unrest now sweeping Greece and the deep hostility expressed towards Greece in some north European policy circles.
The pattern of growth is critical because, under this program, Greece needs to soon grow out of its debt problem. Greece’s debt/GDP ratio will be a debilitating 145% of GDP at end 2011. If we put more realistic growth figures into the IMF forecast for Greece’s economy, e.g., with GDP declining 12% to end 2011, then the debt/GDP ratio may reach 155%. At these levels, with a 5% real interest rate and no growth, the country needs a primary surplus at 8% of GDP to keep the debt/GDP ratio stable. They will be nowhere near that level. The IMF program has Greece running a primary budget deficit of around 1% of GDP in that year, and that assumes a path for Greek growth that can only be regarded as an “upside scenario”.
The politics of these implied budget surpluses remain brutal. Since most Greek debt is held abroad, roughly 80% of the budget savings the Greek government makes go straight to Germans, French and other foreign debt holders (mostly banks). If growth turns out poorly, will the Greeks be prepared for ever tougher austerity to pay the Germans? Even if everything goes well, Greek citizens seem unlikely to welcome this version of their “new normal”.