After many months of pain, protest and market jitters, Greece now seems to be locked into a death spiral that will, at some point, end up in default. Throughout the process I have been hoping, with others, that Greece’s European partners would buy it enough time to have a chance of growing out of its debts. But that now looks all but impossible – and default is the only option.
Greece needs the next tranche of the existing bailout – â‚¬12bn from the euro area and the IMF – before mid-July in order to avoid default. The wider issue is that fact that, under the existing â‚¬110bn bailout plan, Greece was supposed to go back to financial markets and issue long-term debt at the start of 2012. That is clearly impossible.
This realisation means that policymakers have been desperately trying to piece together a second bailout package. Indications from officials suggest that a new plan could total â‚¬120bn, and be enough to fund Greece into late 2014. As before, the hope will be that by then the Greek economy will be growing again, and fiscal deficits will have been eradicated – only with debt on a downward trajectory, as a share of GDP, does Greece have any hope of coming back to the market.
European policymakers have realised that the fallout from a disorderly default would be disastrous – French and German banks would need recapitalising, as would the ECB, and the risk of contagion to Portugal in particular would be high – and are desperately trying to keep the ECB on board with talk of ‘voluntary’ private sector involvement. In practice, that voluntary involvement is likely to be politicians leaning on banks to rollover their holdings of Greek sovereign debt. It is being modelled on the so-called ‘Vienna approach’, when Western banks were persuaded not to abandon their subsidiaries in Eastern Europe. However, the parallel ends about there – central and eastern European economies are now generally growing, whereas the prospect of payback from Greece in the next three years looks slim. If I were holding Greek debt, I would wait for it to mature and then take my money somewhere else, thank you very much. That means national governments will be on the hook – but further support to Greece is still thought to be more palatable than default, even if selling it to domestic taxpayers is difficult.
The real risk, however, is that the Greek public are now saying that enough is enough. The immediate â‚¬12bn that Greece needs will only be supplied by the euro area and IMF if the Greek authorities introduce further austerity measures, worth about â‚¬28bn. That, in turn, will only happen if the Greek government survives tomorrow’s vote of confidence. And with mass demonstrations fuelling political unrest within the Greek Parliament, there is a sizeable chance that it won’t. If PM Papandreou’s government falls tomorrow, it would take some extreme political manoeuvring to have a functioning government in place that could approve any austerity plans. Far more likely would be the prospect of Greek politicians refusing further cuts, which in turn would lead it into default.
The euro area does not yet seem prepared for this potential turn of events. If Greece defaults next month, European policymakers will not be able to claim that they weren’t warned: the writing has been on the wall for some time. If Greece does go under, I would expect politicians to immediately refocus on their own national economies and banking sectors. But that, in turn, does not bode well for Portugal or Ireland. The Greeks, meanwhile, would find themselves faced with even worse austerity – as, cut off from financial markets completely, they would be forced to run a zero budget deficit this year. If you thought the cuts were bad this far, you ain’t seen nothing yet.
There is still a chance, of course, that Papandreou can cling on through the confidence vote, and force through further austerity measures. That would buy Greece, and Europe, more time – but that is all. What genuinely upsets me most about this crisis is that so much of it has been avoidable. If European policymakers had genuinely acted together in the first place, the Greek default now looming on the horizon – and in particular the fallout from it – would not have been half as bad. Fundamentally, policymakers have had 18 months to come up with a solution to this mess, which now is all but certain to include some form of default. But because default is viewed with such fear – despite many examples of orderly restructurings elsewhere, which can genuinely light the way – policymakers have frittered away the time that the first bailout bought them. Whether it is next month, next year, or 2014, it is hard to see anything other than default at the end of this Greek tragedy.