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 After a few weeks of euphoria in financial markets, following action by central banks in the EU and US, QNB Group argues that the focus will soon shift back to Greece, the epicentre of the Eurozone crisis. Greece is unlikely to meet its fiscal targets so its donors will need to decide whether to give it more time to make the necessary adjustments or let it depart the Euro. 

The Greek economy is in its fifth year of recession and its economy has already shrunk by 17% in real terms since mid-2008. It is expected to shrink further as the government reduces spending and private sector investment plummets. In addition, household consumption will fall due to lower net salaries and an unemployment level of 25% and rising.

In April, the IMF forecast that Greece would contract by 4.7% this year and would be flat in 2013. Since then the situation has further deteriorated, and the latest forecast from the Economist Intelligent Unit (EIU) is for 6.1% contraction this year and a further slide of 1.8% in 2013. Thereafter it is expected to return to growth, but the recovery could be slow. The EIU does not expect the real economy to return to its 2007 level until 2029—two lost decades.

En Greece moves back into the spotlight

The shrinking economy has reduced tax income, making the government’s challenge of bringing its deficit and debt under control even harder. The IMF forecasts that the budget deficit will be 7.2% of GDP this year, down from the 9.2% in 2011, but up from the optimistic target of 5.4% set in the original 2012 budget. The government has halted almost all spending aside from wages and pensions, but might still struggle to meet even the IMF’s pessimistic deficit forecast. 

The focus now is on whether Greece can come up with an effective austerity program to bring its deficit back to a level that it could finance from the markets, without relying on multilateral bailouts. The aim, under the terms of the current bailout, is to reach that point by 2015, when the IMF has pencilled in a deficit of just 1.6% of GDP. 

The troika supporting Greece are the European Commission, the European Central Bank and the IMF. They have delayed a €31bn tranche of bailout payment, pending their assessment of Greece’s austerity efforts. The payment is needed by November, or else Greece may be forced to default on its debt, which could lead to a disorderly exit from the Eurozone. The payment is conditional on the troika’s report affirming that Greece is making sufficient austerity efforts to meet deficit targets and bring the debt-to-GDP ratio down from 179% in 2011 to 120% in 2020.

However, the coalition government is divided on some of the cuts required to reduce the deficit by €11.5bn in 2013-14, and has requested a two year extension. This could require another €20bn in bailout funding, to cover deficits in 2015-16, on top of the €240bn already disbursed or pledged, or a restructuring in debt worth the same amount.

Although many of Greece’s creditors, particularly the IMF, are weary of continued slippage in targets, there are signs of a softening from the strictest one, Germany. The first signs of a shift came during a visit to Germany on August 24th by the new Greek prime minister, Antonis Samaras.

Der Spiegel, the respected German news magazine, reported on September 10th that Ms Merkel had recently made a major U-turn in her approach to Greece. Previously she was willing to halt funding to Greece if it failed to meet commitments. Now, however, she has apparently concluded that the consequences of a Greek exit would be too great to bear. In particular, it might be necessary to issue jointly-guaranteed Eurobonds to shore up peripheral countries, which would be very unpopular with German voters ahead of elections in autumn 2013.

There is no consensus on what the precise impact of a Greek exit would be on the Eurozone. Some economists argue that it could be relatively limited and temporary. Others fear that Greek contagion would spread quickly to the other weak countries, threatening to push them out of the euro and creating financial chaos on the scale of the Lehmans collapse in 2008. In August the International Labour Organisation warned that the average level of unemployment in the Eurozone could rise from 11.3% to 13% in the aftermath of a Greek exit. German unemployment could increase from 6.8% to 9%.

The optimists’ case looks stronger since the ECB’s landmark offer on September 6th to buy bonds of struggling countries, such as Spain and Italy, which would help to keep their borrowing costs under control. In addition, on September 12th the German constitutional court gave approval for the formation of the European Stability Mechanism. This is a permanent bailout fund which will have €80bn in paid-in capital spread across Eurozone governments, and a potential lending capacity of €500bn.

A decision on the next Greek bailout payment is expected to be made by early November, soon after the US presidential election. It will be a major item of discussion at the summit of EU leaders in Brussels on October 18th-19th. 

QNB expects that although Greece will not be judged to have fully met its targets, the troika will judge its efforts sufficient to grant the next tranche of bailout money. However, the troika will be less receptive to Mr Samaras’ request for an extension and under this pressure the Greek coalition will probably agree on the necessary cuts. The markets will breathe a sigh of relief, but the Greek crisis may return again in 2013 if the government once again falls behind on its fiscal targets.




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