Spartan times ahead for Greece

The eurozone recession probably extended into the third quarter of 2012.

This has not stopped German Chancellor Angela Merkel and French President Francois Hollande from signalling, in no uncertain terms, that further financial assistance to the so-called problem countries, especially Greece, is dependent on them maintaining their fiscal reform and austerity targets.

The tough talk from those holding the purse strings – Germany and France – follows data pointing to an extension of the eurozone recession. A series of business surveys for the services and manufacturing sectors are consistent with the recession rolling into August. For the eurozone as a whole, the services purchasing managers index fell to 47.5 points in August from 47.9 points in July, remaining below 50 points and signalling contraction in the services sector. For the manufacturing PMI, there was a small rise in August to 45.3 points – but even with this rise, manufacturing output is set to keep falling.

The ongoing recession appears to be of secondary importance to policy makers as they continue to meet to discuss what to do about the government debt problems in Greece and elsewhere.

At the latest meeting, ahead of this weekend's leader's discussion with Greek Prime Minister Antonis Samaras, Merkel and Hollande signalled ‘tough love' as the Greek government seeks some flexibility in the speed and breadth with which the reforms are delivered.

Earlier this week, Samaras said that the Greek government and the people wanted "air to breathe” as the policy reforms to repair the government's finances and the economy were implemented.

Following a meeting earlier this morning, Australian time, Merkel and Hollande made it clear that any flexibility in the implementation of reforms does not mean any relaxation of the end targets for the Greek economy. In other words, financial and other assistance would be withheld if Greece walked away from its commitments.

Merkel said quite directly that "we will, and I will, encourage Greece to continue on its path to reform.”

Hollande also appeared to be direct saying "we want, I want, Greece to be in the eurozone, it's a desire we have expressed since the start of the crisis. It's up to the Greeks to make the effort that is essential for that goal to be met.” While Hollande is generally seen to have more sympathy for some flexibility in the timetable for reform in Greece, these latest comments point to a more hard line approach.

Hollande's comments seem to take account of Samaras' pledge that "we demand no additional money. We stand by our commitments.” Samaras said, "The Germans will get their money back.”

It is easy to have a huge amount of sympathy for Samaras, the other policy makers, and the people of Greece in the current economic climate.

It is worth recalling that the deep economic depression shows no signs of turning. GDP has fallen around 27 per cent from the peak; the unemployment rate is around 25 per cent. These catastrophic economic indicators make the task of fiscal consolidation difficult to achieve. With Greece's government debt already above 160 per cent of GDP, there is a genuine dilemma about what to do. Cut spending and raise taxes too quickly and the ability of the economy to return to growth is kneecapped. Postponing fiscal consolidation will see already unsustainable debt levels climb further.

There is no monetary policy solution, of course, for Greece because policy interest rates are set by the ECB for the eurozone as a whole and Greece, having euros as its currency, is unable to have a currency depreciation to boost its export sector. Unless of course, Greece leaves the eurozone.

Despite these economic problems, Germany's Finance Minister, Wolfgang Schaeuble, is advocating an even tougher approach to the conditionality of the bailout money, saying "more time is not a solution to the problems” and that Europe's assistance for Greece had already "gone to the limits of what is economically viable".

In a similarly brutal assessment, Dutch Finance Minister Jan Kees De Jager suggested that Germany should "stick with its strict position" and giving Greece more time would not help.

There are further talks scheduled for the days and weeks ahead from the leaders, finance ministers and the European Central Bank. No doubt there will be talks for many more years as the eurozone problem will be an entrenched issue for years to come. Even on optimistic projections, Greece will still have government debt levels equal to about 120 per cent of GDP in 2020 – an unsustainable level on just about any measure.

It is worth highlighting that Greece is not the only problem economy in Europe. Spain, Portugal and Ireland remain under stress, while there are clear tensions in the sustainability of the public finances of Italy and France itself.

There seems no doubt that the eurozone will experience further economic grief over the next year or two. The worry is that this grief will continue to spread through to the rest of the world.