Resolving Greece's Debt Crisis

Greece's debt crisis has turned out to be unsustainable. Greek banks are closed; government is rationing limited available cash to its citizens.  It is highly likely that Greece will soon exit from the Eurozone. Its aftermath in Greece and beyond is uncertain.

Conflicting views are there as to why Greek economy has reached this dire state. A majority view is that the policy mix which Greece's creditors including IMF notably negotiated with Greek government has proved counterproductive. It has been heavily biased towards 'austerity,' which led to sustained economic contraction. The austerity measures forced countries like Greece to undergo painful deflation of wages and other costs to become competitive. It also failed to bring about the much needed price competitiveness.  Greek GDP data shows that the economy began contracting just after the global financial crisis had gripped the world economy in 2009. Greek economy indeed contracted by one-third of its pre-crisis level. Greek macroeconomic data further show that in pre-crisis time Greece experienced a persistent saving-investment gap and hence a soaring current account imbalance. No doubt, this was possible as coeditors perceived Greece, then a new member state of Eurozone, to be a safe haven for lending and investment. 

Net capital flow to Greece, though, surged to finance ballooning current account deficits that did not expand Greece's productive capacity. The growing accumulation of external debt seemed to have financed excessive dissaving on the part of both Greek private and public sectors. Data indicate that investment - GDP ratio in this benign time remained stagnant at around 20 percent. It is ironic that neither IMF nor Greece creditors in the Eurogroup timely issued a warning flag that the Greek stock of foreign debt was becoming unsustainable.

Changes in real exchange rate from 2001 to 2009 indicate how Greece let its export production down. Real effective exchange rate (REER), a measure of relative price of Greece's home goods in terms of foreign goods, in fact, observed a sustained appreciation by more than 30 percent in this time. This happened as the surging capital flow continued to shift Greek aggregate demand to the right and the domestic price kept rising. As an outcome, Greek exports lost their price competitiveness in the rest of the world and its current account deficits widened. A false signal in recent movements of REER deserves further explanation. It is that austerity measures led to serial contraction of Greek economy after the first quarter of 2010 and accompanied a moderate real devaluation. Export-GDP ratio also rose in this time. This must not be a ground of further austerity on the premise that in the same time both GDP and investment-GDP ratio declined precipitously.

The global financial crisis in 2009, in fact, opened fault lines in Greek economy. By the end of 2009, capital flights out of Greece seem to have begun. This is indicated by an increasing government bond yield since 2010. Greece's creditors since then negotiated an economic policy which tied further lending to the country to the policy mix of austerity. This proved tragically counterproductive.  The austerity, in fact, washed away investment in Greece economy. Investment-GDP ratio rapidly declined from 25 percent to less than 10 percent over the last six years. Austerity did not increase productive capacity of Greece's economy; instead it brought the economy to a stop.

Faced with the same kind of policy mix such as cutting pension benefits of the elderly and reforming tax policy, Prime Minister Alexi Tsipras had no option but to come back to the Greek electorate. Greek people overwhelmingly approved the 'No' referendum on July 5, 2015. For more than three weeks, Greece's PM Tsipras could not offer any credible deal to the country's creditors while its banking system remained shut. A new bailout deal was ultimately struck on July 12. But the deal has unfortunately become what Greek people just rejected on July 5. IMF has also become uncharacteristically critical of the deal. It said Greece's public debt was now "highly unsustainable" and urged debt relief on a scale "well beyond what has been under consideration to date". The IMF told European finance ministers that a new bailout should include measures to restructure the country's debt. Tsipras is facing a rebellion within his left-leaning Syrizia coalition. 

The new deal included further spending cuts, more taxes and an elaborate scope for policy interventions by the creditors. The new Greece bailout programme will only affect Greece's debt structure not its debt sustainability. It is in all measures designed to bail out Eurozone's private creditors with European taxpayers' money. It will very likely aggravate an already alarming and protracted economic downturn, compounding poverty and exceptionally high unemployment. A case of Grexit is deferred, not avoided. 

Greece's desire to stay within Eurozone is a seriously constrained choice for its economy. This is because it will continue to plague price competitiveness of Greece's exportables in the rest of the world. Net foreign spending on Greek home goods will thus not rise and a sustained economic growth in Greece is unlikely. In the present scenario, this would not resolve Greece's investment problem, nor will it bring about a substantial relative price decline which Greece needs urgently. One must not forget that more than a quarter of working age people in Greece are now unemployed.

The Greek government might actively consider adopting a new currency. A new currency could facilitate the recapitalisation of the domestic banking system, bring in foreign direct investment, and bring about a resolution to its macroeconomic imbalances. It is certain that European taxpayers in the developed Euro area will ultimately have to absorb substantial losses to their claims on Greece.

The writer is an Associate Professor of Public Policy, University of Dhaka and Director of Accounting of Capital Market Development. He won the Global Development Network (GDN) Medal for Research on Development in 2010. E-mail: mizan@du.ac.bd