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Sorting out the Greek issue

The aim of this short article is to set the ideas straight regarding the Greek situation. Several issues are considered, the first of which being that of economic growth. If the latter does not make any progress, it will be very difficult to reach public finance stability. The second issue is about helping the Greeks improve their situation and the final issue deals with renewing that support.

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Greece faces the challenge of achieving public finance stability with a lagging economic growth. Since the end of 2008, economic activity has been contracting in Greece. The historical evolution of Greek GDP shows a sustained contraction from its latest peak reached during the third quarter of 2008. Since this peak, Greek GDP has shrunk by 10% in terms of volume (-4.1% annualized) and by 7.1% in terms of volume (-2.9% annualized).

The economic contraction weighs heavily on public finances when the primary aim consists of stabilizing the public debt to GDP ratio. The dynamics of this ratio are dependent on the primary budget balance (Receipts less expenditure excluding debt interest) and on the gap between the public debt interest rate and the nominal GDP growth rate. Based on this fact, we can better grasp the case. If the primary balance is negative, debt accumulates. The public debt to GDP ratio rises when the interest rate goes up (rise of the numerator) but decreases with GDP growth (rise of the denominator). The interest rate being positive, when the nominal growth rate is negative, the effort required to stabilize the public debt to GDP ratio is considerable. A simple calculation can be made to illustrate the workings of these different elements.

We base the following calculation on a 6% nominal interest rate and a 150% debt to GDP ratio. With a nominal growth rate of zero, a primary surplus representing 9% of GDP is required to stabilize the debt to GDP ratio. With a 4% growth rate, the primary surplus must be equivalent to 2.9% of GDP and with an 8% growth rate, the debt to GDP ratio can be stabilized even with a negative primary surplus representing -2.8% of GDP.

In other terms, economic growth is the most important element that needs to be considered when analyzing public debt dynamics since the rate of interest is defined by global market conditions.

Nowadays, the Greek economy is contracting even in nominal terms. It is impossible for it to stabilize its debt to GDP ratio unless it applies an extremely restrictive budget. However, too much restriction can hinder economic growth. This risk has been highlighted in the Troika report which was published on the 3rd June 2011.

It is possible to further this budgetary constraint analysis with economic growth rates evolving in different time dimensions or with a defined debt to GDP objective. This will not radically change the analysis since the underlying logic remains the same. (In order to measure the effort that needs to be done, we must compare the primary balance figure required to stabilize debt and the primary balance figure of -4.7% observed in 2010. This effort has to be permanent).


The worsening of Greek public finances had reached such an extent in 2009 that Greece was denied access to financial markets. No one wanted to shoulder Greek risk. The result has been a significant rise in interest rates.

With weak economic growth coupled with public finance disequilibrium, Greece could no longer find the means for short term financing and medium term prospects had severely deteriorated. Aid coming from the Europe, the ECB and the IMF was meant to fill in for this missing financing.

As part of the deal, Greece agreed to apply very rigorous measures in order to reduce its public deficit and consequently allow the latter to converge towards a level that would allow it to stabilize its public debt to GDP ratio.

The first objective has been to reduce public spending. The latter had increased significantly since the beginning of the crisis. Greece needed to come back to its initial level prior to the crisis. The second goal consists of improving fiscal returns.

The objectives had been properly defined. The Greek government was to apply the restrictive measures on its budget and the troika would finance this government.

This plan has not properly worked for two reasons. The first reason was because the Greek economy was unable to benefit from the improving dynamics of world trade. It is not the only European country facing this situation since even a country such as France has failed to raise its exports to a level that could match the full potential of improved world trade. The other reason explaining the plan’s failure is the heavy dependence of the Greek economic cycle on public spending. The restrictive measures have negatively impacted economic activity and job creation. Consequently, economic activity has remained at deceivingly low levels and the employment situation has deteriorated very rapidly. Between May 2008 and March 2011, the amount of unemployed people has increased by 150%. The internal market could not progress and generate growth.

In 2010, the Greek economy’s contraction persisted even when a recovery was taking place in most European countries.


The ongoing economic contraction has not enabled the desired improvement in Greek public finances at the start of 2011. The figures published over the first five months of the year have deteriorated when compared to those of 2010 over the same period. The budget deficit is slightly higher this year than in 2010 and most importantly, the primary deficit (balance excluding interest paid on debt) is significantly higher than that of last year.

In other terms, the plan carved out during the spring of 2010 has failed. The questions that were confronted last year are still confronted this year but with greater acuity. Economic contraction partly explains this result but the plan itself needs to be reviewed. Past experiences that were sought when the plan was developed were not similar this time since a variable factor adjusted itself thus enabling the economy to grow again. Generally, this adjustment took place with currency devaluation. In the current situation, such an adjustment cannot happen. Nominal adjustment goes through wages which by their very nature and specific contract considerations cannot be adjusted spontaneously.

The process is a long one. Based on this fact, part of the adjustment was carried out on economic activity and jobs which further hindered the public finance stability process. The major consequence has been that Greece is still unable to fulfill its commitments and requires additional support. However, a distinction needs to be made between immediate measures and longer term ones.

The first short term step is to deliver the 12 billion dollar tranche by the end of the month of June 2011. It is necessary for the short term financing of the Greek economy. This credit is part of the plan set up during the spring of 2010 but is however subject to the assessment of the Greek situation by the troika. The report submitted on the 3rd June 2011 highlights insufficient progress. This 12 billion dollar tranche can only be delivered if a new restrictive budget plan is set up aiming at reducing public finance disequilibrium. This plan aims at reducing public deficit by 28.4 billion dollars. Public deficit would shift from an estimated 7.4% in 2011 to 1.1% in 2015. This will be achieved mainly through a spending reduction (-8% of GDP on spending excluding interest between 2011 and 2015). Receipts will increase by only 0.6% over the period. There are also planned asset sales of 50 billion dollars over the period. Who will buy those assets is a major question since over the last ten years foreign investors have only bought the equivalent of 2 billion dollars every year. The target is far from being achieved.

The second step is about Greece’s inability to find liquidity on the market. Greece needs assurance regarding its medium term financing. This sets the idea for a second financing plan which would complement the first one which was carved out during the spring of 2010. It would take on a new dimension by including private investors. The idea would be to extend the maturities of the debt certificates which will expire over the next few years. There would be no need to raise capital to reimburse investors immediately. The reimbursement would take place later when the macroeconomic situation will have improved.
This debt restructuring must be carried out on a volunteering base. The conditions surrounding asset extension will need to be known and care needs to be taken that the debt holders will not be negatively impacted. The institution holding Greek assets must act in the interest of its clients.


The Greek situation remains very fragile since the deterioration of its public finances is such that it cannot meet its commitments. There is no guarantee that further constraints will improve the situation and reduce uncertainty.
The risk is that social tensions may increase in Greece which would consequently force a review of the model currently applied. Limiting such a risk will require the Europeans to act strongly and quickly over an extended time frame. The difficulty resides in avoiding a contagion towards other European countries.
The issue discussed is that of a country facing a very high level of debt while suffering from low economic growth since it is handicapped by restrictive policies designed to stabilize public debt. No adjustable variable which would enable the Greek economy to recover is present. It is therefore necessary to provide new means to the Greek government by isolating the debt that can be qualified as excessive and which is paralyzing it. The actions need to be defined but the European stabilization fund could handle this job or even the ECB by the following the example of the Fed which intervened in the MBS market to suppress part of the risk present on financial markets.
It is obvious that while Greek accounts are being freed from their debt, Greece will have to review its functioning in order to avoid unwanted consequences impacting the Eurozone economy and the rest of the world economy.

Philippe Waechter , June 2011

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