Heroic assumptions on Greece's shoulders

The deal reached between Greece and its lenders is based on economic and budget forecasts that will be difficult for Greece to deliver on.

All of a sudden, the problems in Greece are fixed… or are they?

The good news is that the next tranche of bailout money for Greece has been approved and the Greek government is imposing fiscal austerity as it sticks to its end of the bargain to qualify for the cash handouts. The bad news is the fact that Greece remains in a deep economic depression. GDP is more than 21 per cent below the level of five years ago, the unemployment rate is 25 per cent and the consensus forecast is for GDP to fall sharply in both 2013 and 2014, making the economic slump longer than even the weakest country experienced during the 1930s Great Depression.

There is other good news. Greece's government debt will fall by around 75 per cent of GDP between 2014 and 2020. The bad news is that even after this stunning debt reduction, and based on what can only been seen as heroic assumptions, government debt in 2020 will still be 124 per cent of GDP.

With Greece not having its own currency to devalue or its own interest rates to cut, the outlook for the economy is still very problematic. With few policy levers to pull, Greece has to rely on the European Union, the European Central Bank and the International Monetary Fund for finance to help it cover its debt obligations and in time, set the economy back on a path to economic growth.

The European Union finance minister agreed to give Greece the next €43.7 billion tranche of bailout money and in doing so, softened the terms on which the money is given. Greek government debt is projected to not only fall to 124 per cent of GDP by 2020, but IMF managing director, Christine Lagarde, estimates that it will keep falling after that and will be "substantially below” 110 per cent of GDP by 2022.

For its part, Greece is delivering a range of fiscal measures, all of which are designed to cut debt and move the budget to a large and sustained surplus. The fiscal austerity includes the usual suspects – cuts to public service numbers, wages and pension provisions, a tightening in tax collection arrangements, hikes in government charges, a series of privatisations and cuts in social security and welfare payments.

In announcing the latest bail out, Olli Rehn, the European commissioner for economic and monetary affairs, said "Greece has already come a very, very long way and tonight the eurogroup has rightly recognised that”. This was welcomed by the Greek finance minister, Yannis Stournaras who said "Greece has fully delivered its part of the agreement, so we expect our partners to deliver their part”. Prime Minister Antonis Samaras also welcomed the deal, saying "a new day begins for all Greeks".

The objective of Greece to reduce government debt is, as always the case, based on a number of economic and budget forecasts and assumptions. The debt to GDP forecasts are based on Greece registering growth of 4 per cent in nominal GDP over the full forecast horizon and the government running a primary surplus on its budget (that is, a surplus excluding the debt servicing or interest costs) of 4.5 per cent in each and every year to 2020.

These look to be heroic assumptions, at least for the next year or two.

The consensus among market economists is for real GDP in Greece to fall by around 4 per cent in 2013 and a further 1 per cent in 2014. If correct, there will be a growth and revenue shortfall, which will raise the starting point for debt reduction. Indeed, it seems likely that the government debt starting point target will be revised higher at some stage in 2013. Presumably this risk is one reason why Greek bond yields remain over a thousand basis points above those in Germany.

The path for debt reduction is also based on a set of very generous terms, pushed for by the IMF. In moves worth about a 20 per cent of GDP cut in debt, the IMF was instrumental in helping Greece through a program including Greek debt buybacks and the return of profits made by the ECB on its holdings of Greek bonds to the Greek government. It also involved a cut to the interest rate paid by Greece on its loan facility, an extension to the timetable for interest repayments and a deferral of some interest repayments.

These very generous conditions are clearly designed to ease the pain of reform. That said, it looks like Greece will have several more years of genuine economic hardship before the turning point comes.

Eurogroup chairman Jean-Claude Juncker perhaps summed up the feeling, saying, "This is not just about money. It is the promise of a better future for the Greek people and for the euro area as a whole".


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