Greece Hurtles Toward the Unknown
Greece missed a €1.55 billion payment to the International Monetary Fund last night, joining Zimbabwe, Sudan, and Cuba as the only countries to not repay the IMF. Greece has distinguished itself as the first developed country on this list. The country is burdened by a debt-to-GDP ratio heading toward an unsustainable 180 percent, an almost 30 percent slide in its GDP over the past five years, and massive youth unemployment—stuck at around the 50 percent level. These factors brought the far-left-of-center Syriza party to power in January. After a long sequence of mutual recriminations, the Syriza prime minister, Alexis Tsipras, announced that he would put the creditor-demanded austerity program to a voter referendum next Sunday, July 5.
The call for referendum led the European Central Bank, which was providing the lifeline to Greek banks through the Emergency Liquidity Assistance program, to cap the financial backing at its current level of about €89 billion. In turn, the ECB decision accelerated the withdrawal of bank deposits by Greek savers. With long lines at ATMs over the weekend, the government has closed banks and the stock market indefinitely. Capital controls have been imposed, with daily withdrawals restricted to €60 per individual.
The Greek public has inconsistent preferences regarding the creditors' program. It overwhelmingly wants to stay in the euro zone and enjoy the benefits of the common currency but, at the same time, is unwilling to accept the additional austerity that creditors require if Greece is to remain a member of the club. These conflicting motivations will be at play during the upcoming referendum. Tsipras has recommended a no vote (rejecting the creditors' proposals) while the creditors urge a yes vote, indicating that rejection could push Greece out of the euro zone. Contradictory, and often shifting points of view on both sides, have characterized recent negotiations.
Capital markets as well as the creditors involved were apparently surprised by Tsipras' call for the referendum, which explains the 350-point plunge in the Dow Jones industrial average Monday and the sharp fall in U.S. Treasury and German bund yields as investors sought safe havens. However, the meetings I had in Athens in May suggest that default—and an eventual exit from the euro zone—remain the probable outcome of the Greek drama. These events are reminiscent of the Latin American experience in which seven years of austerity—and expanding debt—did little to resolve the debt crisis that hit in 1982. Only debt-reduction and interest-reduction schemes introduced in 1989 as part of the Brady Plan allowed the countries to lower their obligations to levels that could be serviced and grow their economies as well. Since there was no such element in the German-led plan put before the Greeks as late as last week, it was clear that the Mediterranean nation had little to gain from it.
What explains the creditors' unwillingness to allow debt reduction? In the Greek debt restructuring that European entities and the IMF administered in 2010 and 2012, private bank lenders were taken out with relatively small losses. Instead, official bodies became the principal creditors to Greece, holding about 80 percent of the obligations. Consequently, if "haircuts" are deemed necessary, the taxpayers of other European Union countries would eventually bear the losses. In particular, German Chancellor Angela Merkel would have to explain to her voters why they must accept more losses to enable Greeks to receive better pension benefits than the Germans themselves do! And in Ireland and Spain, both of which accepted the pain of austerity, there is resistance to allowing the Greeks to get away easy. This is the political conundrum European creditors face.
As for the IMF, it has a record of forecasting in 2010, and again in 2012, that any austerity-related recession in Greece would be short and shallow. Both sets of projections proved highly unrealistic and wildly optimistic. The Syriza government and a section of the Greek public believe that the IMF made these rosy projections so previous Greek governments (which were friendlier to the IMF than the current one) could sell them to the public, enabling private creditors to get off the hook. It was clear from my recent meetings in Athens that these views have fostered skepticism about any future economic forecast issuing from the IMF or the European Union.
Whether the current situation evolves into a Greek tragedy or has a happier outcome, one thing is clear. The most recent program presented to Greece by the IMF, ECB, and the EU would involve no principal loss for the creditors, while the Greeks would be asked to accept more pension cuts and higher taxes. As such, it does not follow the basic principle of corporate debt restructuring, that when a company goes into liquidation, creditors are also at fault for having lent excessively and, therefore, should accept some of the loss.
Until the two-sided nature of losses in sovereign defaults—as in corporate bankruptcies—is recognized, the fallout for global financial markets may well continue.