Blog Post

Greek choices after the elections

In the days ahead of the Greek snap elections on 25 January 2015 a huge range of opinions has appeared on what Greece and its lenders should do. One could write a lot on what happened, who is responsible for desperate social hardship and what should have been done differently. But after the elections, both Greece’s new leaders and euro-area partners should look ahead: given the status quo, what are the real choices?

By: Date: January 23, 2015 Topic: European Macroeconomics & Governance

A version of this post appeared in ISPI Dossier.

In the days ahead of the Greek snap elections on 25 January 2015 a huge range of opinions has appeared on what Greece and its lenders should do. A large group of people are saying that Greek public debt is unsustainable and a significant part of it should be written off. In their view, the Troika is responsible for the deep crisis, austerity has failed, and the fiscal space gained from the debt write-off should be used to stimulate growth.

Another group says that irresponsible pre-crisis Greek policies, as well as the extremely large, 15% of GDP budget deficit in 2009, necessitated the bail-out in 2010. Implementation of the bail-out conditionality was incomplete and the Geek public sector is so inefficient and so much depends on cronyism that it is not surprising that the Greek crisis became so deep.

As always, both sides have some truths but none of these explanations is complete. One could write a lot on what happened, who is responsible for desperate social hardship and what should have been done differently. But after the elections, both Greece’s new leaders and euro-area partners should look ahead: given the status quo, what are the real choices?

Exit is not an option. Greece would enter another deep recession, which would push unemployment up further and reduce budget revenues, requiring another round of harsh fiscal consolidation: exactly what opposition parties want to avoid. (This effect is forgotten by those who argue that since Greece has a primary budget surplus, it has now the option to default and exit.) Euro-area creditors would lose a lot on their Greek claims and private claims on Greece would also suffer (see our earlier post here). Moreover, exit would also risk the stopping of EU-budget related inflows to Greece (cohesion and structural funds, agricultural subsidies): in 2013 Greece received a net payment of 2.9 % of GDP from the EU budget. This was a transfer (not a loan) and the country would receive similar transfers in the future too.

Debt write-down is extremely unlikely – and unnecessary as well. Any level of debt is sustainable if it has a very low interest rate. Japan is a prime example: gross public debt is almost 250 % of GDP, while the average interest rate is 0.9 percent per year. Despite the very high Japanese public debt, there is no talk about its restructuring.

Loans from euro-area partners to Greece carry super-low interest rates and also have very long maturities. The lending rate from the European Financial Stability Facility (EFSF) is a mere 1 basis point over the average borrowing cost of the EFSF, which is around 0.2 percent per year currently. The average maturity of EFSF loans is over 30 years with the last loan expiring in 2054. Moreover, in 2012 the Eurogroup agreed on a deferral of interest payments of Greece on EFSF loans by 10 years, implying zero cash-flow interest cost on EFSF loans during this period. The interest rate charged on bilateral loans from euro-area partners is Euribor plus 50 basis points, which is currently about 0.56 % per year: another very low value (which could be lowered further, as we argued here). Bilateral loans have a long maturity too: they should be gradually repaid between 2020-2041.

One can say that yields will not remain so low forever and if ever growth and inflation will pick up in the euro area, interest rates will increase. Unfortunately, this is in the distant future and therefore the cash-flow gain for Greece from stopping interest payments to euro-area partners would be very low in the next few years.

In fact, according my calculations, one of the demands of Syriza leader Alexis Tsipras will be likely met this year, even without any change in bail-out terms: actual interest service costs of Greece will likely be below 2% of GDP in 2015. Table 1 shows the situation in 2014. Total interest expenditures of Greece amounted to 4.3 % of GDP. However, interest paid to the ECB and euro-area national central banks (NCBs) is returned to Greece (if Greece meets the conditions of the bail-out programme) and interest payments on EFSF loans are deferred. If we subtract these, interest payments were only 2.6% of GDP in 2014, well below the values of other periphery countries. Given that interest rates have fallen significantly from 2014, actual interest expenditures of Greece will be likely below 2% of GDP in 2015, if Greece will meet the conditions of the bail-out programme.

Table 1: Interest burden on public debt in 2014

Source: the first two data columns are from the November 2014 forecast of the European Commission; the third column is my calculation.

Note: end-2013 value for gross public debt, 2014 value for interest payments. ECB=European Central Bank. NCBs=national central banks. EFSF= European Financial Stability Facility. Greece receives from the ECB/NCBs both the interest it pays on their Greek bond holdings and the capital gains of the central banks from Greek bonds (most of the bonds were purchased below face value). In my calculation I only excluded the interest component.

Since the actual debt servicing cost of Greece is low, it is extremely unlikely that parliaments and governments of euro-area lending countries would decide to cancel their Greek loans and raise taxes at home to cover the losses.

Maturity extension and further cut in interest rate: yes. While euro-area loans to Greece already have extremely long maturities, further extension is possible. Whether the average maturity is 30 years or 40 years, there is not a big difference. Moreover, the 50 basis point spread over Euribor, which is charged on bilateral loans, can be abolished without leading to direct losses to euro-area partners. As was argued with Pia Hüttl, such changes would imply a 17 % of GDP net present value gain for Greece over the next 35 years. While this would not be an upfront funds that could be spent, on average the primary surplus of Greece could be about 0.5 % of GDP lower in the next 35 years, which is sizeable.

A new financial assistance programme: yes. As we argued with André Sapir and Guntram Wolff a year ago, a third programme should be put in place to take Greece out of the market until 2030. Even if the currently very high market interest rates for Greece will fall, they will likely remain too high.

Easing fiscal policy: perhaps. In our paper with Sapir and Wolff we also argued that the new programme should be accompanied by enhanced budgetary commitments by Greece, whereby Greece should reach a balanced budget by 2018. Hoverer, due to the fall in interest rate and an improvement in economic activities (2014 was the first year with modest economic growth, with 2-3 percent growth expected for 2015), in November last year the Commission forecast a balanced budget already for 2015, despite a forecast decline in structural primary surplus (Figure 1). In fact, the expected decline in the structural primary surplus would imply fiscal easing and therefore the expected improvement of the actual primary balance (red line of the figure) is expected to come mainly from the improved economic situation. If the maturities of euro-area loans to Greece are lengthened and the 50 basis points spread on bilateral loans is scrapped, the primary surplus could be reduced by an additional half percent of GDP. Therefore, there would be some room for manoeuvre to ease the social pain and to help growth with some public investment.

Figure 1: Primary budget balance of Greece, % of GDP, 2003-2016

Note: the primary balance is the budget balance excluding interest payments. The structural primary balance is the estimate of the underlying position of the primary balance, by excluding the impact of the economic cycle (such as the negative impact of recession on tax revenues) and one-time revenue and expenditure measures (such as bank rescue costs).

Source: European Commission forecasts: the November 2014 forecast includes data on the structural balance from 2010 onwards, for earlier years we used the May 2014 forecast.

Structural reforms: yes. Even Syriza argues that Greece needs major structural reforms. Yet it may be difficult to find an agreement between Greece and the Troika, because many of the current plans of the Greek opposition parties are in diametric opposition to reforms agreed under the financial assistance programme. But a compromise has to be found: both sides have strong incentives to agree and structural reforms have to be part of the comprehensive agreement.

A European boost to economic growth in the euro-area periphery: should be yes, but low hopes. With Sapir and Wolff we also argued for the need for European support to growth throughout the euro-periphery. While I continue to think that there would be a strong rationale for it, unfortunately I see little political reality.

European assurance for Greece against adverse shocks: yes. Even if Greece will cooperate with euro-area partners and will fulfil its commitments, such a high debt ratio is sensitive to adverse risks, like weaker growth, lower inflation or higher interest rates. Therefore, some sort of European assurance is needed for Greece to eliminate the uncertainty over Greek debt, if Greece meets loan conditions. Otherwise, the uncertainty may deter the investment climate, even if euro-area loans have super-long maturity and low interest rates. One option would be to index official loans to Greek GDP as I suggested in a 2012 paper. Thereby, if the economy deteriorates further, there will not be a need for new arrangements, but if growth is better than expected, official creditors will also benefit. Another option would be to commit on the part of lenders to reduce loan charges below their borrowing costs, should public debt levels prove unsustainable despite Greece meeting the loan conditions (as we argued with Sapir and Wolff).

What are the chances for such a comprehensive agreement which could be claimed as victory by both sides? I think it is higher than many commentators think, for two main reasons.

  • First, lack of an agreement may lead to Grexit, which would be so bad for all that both the new Greek leadership and euro-area partners have very strong incentives to avoid it.
  • Second, there are some reasonable options to agree on the reduction of the debt burden and easing fiscal policy, as I outlined above. Thereby, the new Greek leadership could claim that it achieved a major reduction in the cost of debt service and got some fiscal space to ease the social pain and boost growth, while European partners could tell their people that they only extended the loan maturities and eliminated the gap between their own borrowing costs and their lending rate to Greece, thereby taxpayers should not suffer loss.

Certainly, negotiations may not work out nicely. We do not know yet if a government will be formed right after the elections, or a new election will be needed later; Greece may run out of time. When a government is formed, negotiations could be suspended, perhaps repeatedly, which would create further uncertainty. Such uncertainty would lead to deposit withdrawal from Greek banks and deteriorating economic and fiscal outlook. Some euro-area partners may say no to certain parts of the agreement even if other euro-area partners agree. Some members of the new Greek parliament may say no even if the new government and most of its parliamentary members are in support. I may have also incorrectly assumed that the responsible decision makers think rationally. Therefore, there could be many pitfalls for an agreement, yet the Grexit threat will be hanging over the negotiators like the sword of Damocles.



Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic


Integrity of official statistics under threat

Andreas Georgiou has unwittingly become an international icon for statistical integrity. His continuing politically-motivated persecution is highly damaging for Greece, and more broadly for the credibility and reputation of the euro area.

By: Edwin M. Truman and Nicolas Véron Topic: European Macroeconomics & Governance Date: August 10, 2018
Read article More on this topic More by this author


Griechenland braucht einen Neuanfang

This was first published by Die Zeit. Acht Jahre nach Beginn des ersten Hilfsprogramms für Griechenland ist es soweit – Griechenland soll wieder auf eigenen Füßen stehen. Die Eurogruppe soll heute das Ende des dritten Hilfsprogramms beschließen und die Modalitäten für die Zeit danach definieren. Ziel sollte es jetzt sein, einen tragfähigen Ausstieg aus dieser für alle Seiten […]

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 3, 2018
Read article More on this topic More by this author

Blog Post

The European Union must defend Andreas Georgiou

Andreas Georgiou’s case raises disturbing questions about the integrity of European statistical processes. Forceful action by EU authorities on Mr Georgiou’s case is long overdue. The European Union also needs to consider reforming its statistical framework to ensure a similar scandal cannot recur.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: June 26, 2018
Read article More on this topic

Blog Post

Is the ECB collateral framework compromising the safe-asset status of euro-area sovereign bonds?

Central banks’ collateral frameworks play an important role in defining what is considered as a safe asset. However, the ECB’s framework is unsatisfactory because it is overly reliant on pro-cyclical ratings from credit rating agencies, and because the differences in haircuts between the different ECB credit quality steps are not sufficiently gradual. In this note, the authors propose how the ECB could solve these problems and improve its collateral framework to protect its balance sheet without putting at risk the safe status of sovereign bonds of the euro area.

By: Grégory Claeys and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: June 8, 2018
Read article More on this topic More by this author


Greece must capitalise on its growth momentum

Better-than-expected growth performance reflects the underlying positive changes in the Greek economy – but net investment is in fact negative, while Greece has various institutional weaknesses. Further improvements must be made regarding Greece’s attractiveness to foreign direct investment. A new (at least precautionary) financial assistance programme would improve trust in continued reforms and also address eventual public debt financing difficulties.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: March 26, 2018
Read article More on this topic More by this author

Blog Post

Is Greece’s labour market bouncing back?

After rapid increases in unemployment and large wage reductions, Greece’s labour market is showing signs of recovery. Certain sectors of the economy are showing strong employment growth, which could hint at a broader economic recovery.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: June 14, 2017
Read about event More on this topic

Past Event

Past Event

CANCELLED - What should be Greece's next growth model?

Due to unforeseen circumstances, we will have to cancel this event.

Speakers: Kyriakos Mitsotakis and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 8, 2017
Read article More on this topic More by this author


Debt relief or a fourth financial assistance programme for Greece?

The Eurogroup faces a difficult choice on Greece — implementing a debt reduction plan drastic enough to make a return to market borrowing possible, or agreeing to a fourth financial assistance programme and continuing to fund Greece at the preferential lending rate.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: May 22, 2017
Read article More on this topic More by this author

Blog Post

Should we worry about Greek banks?

Earlier this month, the IMF and the European institutions clashed over conditions for sustainability of the Greek debt. One of the main disagreements seems to be the evaluation of the Greek banks’ health. Whose assessment should be trusted and are there reasons to worry?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: February 23, 2017
Read about event More on this topic

Past Event

Past Event

Game Over – The Inside Story of the Greek Crisis -Drawing the broader lessons for Europe

Solvay Brussels School and Bruegel are co-organizing an event at which George Papakonstantinou and André Sapir will discuss the Greek crisis and its social and economical impact over the last 6 years.

Speakers: André Sapir, Guntram B. Wolff and George Papakonstantinou Topic: European Macroeconomics & Governance Location: Avenue Franklin Roosevelt 42 Brussels, 1050, Ixelles Date: December 6, 2016
Read article More on this topic More by this author

Blog Post

Not so low: A review of Paul Blustein’s book on the IMF and the euro area crisis

"Laid Low" is an important addition to the burgeoning literature on the euro-area crisis and its main contribution is to assemble essential factual material for further analysis.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: November 3, 2016
Read article More on this topic More by this author

Blog Post

The IMF’s performance on financial sector aspects of the euro area crisis

The recently published in-depth evaluation of the International Monetary Fund (IMF)’s role in the euro area crisis highlights important contrasts in the area of financial services. The IMF provided highly valuable analysis and recommendations to the EU on its banking sector and related policies. In individual countries (leaving aside Cyprus and the second Greek programme, not covered by this evaluation), the financial-sector aspects of the IMF’s interventions were highly successful in Ireland and Spain, ambiguous in Greece, and a missed opportunity in Portugal.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: August 29, 2016
Load more posts