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Tuesday, 31 January 2012

PSI, Budget Commissioner for Greece: Implications for the Sovereign Debt Crisis and the future of the Eurozone


So a PSI is almost a done deal for Greece. Is the beginning of the end for the Greek-cum-Eurozone crisis? Not On Your Nellie…

In my last blog I signed off with some fundamental concerns about both the impact and sustainability of the process in Greece set against a clear lack of consensus and domestic ownership for the austerity forced in Greece – either among the rulling classes or across society more generally (and to date putting the Greek situation at odds with Italy).

What is clear from both the last IMF report in December and the data so far is that the economic compression in Greece is worse than baseline forecasts from even mid-2011. Whilst the Fund is focussing on a medium-term path to sustainability of debt to 120% of GDP and a return to growth fostered by fiscal and structural reform, the facts are that an economy heading south does not bode well for any projections   – leaving alone the intention of widening the tax base or ramping up the efficiency of tax collection.

There are no signs of productivity growth but instead, as to be expected, indications of internal devaluation Latvian-style through a decline in domestic wages....and unlike Latvia growing signs of ever-increasing domestic opposition as the pain of austerity bites deeper.

How long can this continue?

Economist's Answer: …until marginal gain = marginal cost!...

Or put another way, there is a argument to be made that it is in the interests of (at least the elite) Greeks to secure the maximum in terms of transfers, aid, soft financing and reduction in Net Present Value of external liabilities….until it becomes too painful and the marginal cost/pain outweighs the marginal gain.

Have we reached the point of equality of the marginal changes?

The leaked terms of the new EU-IMF deal has some pre-conditions which both crank up the requirement for further cuts in civil servants by a reported 100-150k and …here are the interesting parts:

i.                     A legal commitment to prioritise future debt service  and an implicit requirement to meet future budget constraints due to non-disbursement of traches through cuts in primary expenditure.
ii.          A formal “Transfer of National Budgetary Sovereignty….see the full text below:

Budget consolidation has to be put under a strict steering and control system. Given the disappointing compliance so far, Greece has to accept shifting budgetary sovereignty to the European level for a certain period of time. A budget commissioner has to be appointed by the Eurogroup with the task of ensuring budgetary control. He must have the power a) to implement a centralized reporting and surveillance system covering all major blocks of expenditure in the Greek budget, b) to veto decisions not in line with the budgetary targets set by the Troika and c) will be tasked to ensure compliance with the above mentioned rule to prioritize debt service.

The new surveillance and institutional approach should be formulated in the MoU as follows: “In the case of non-compliance, confirmed by the ECB, IMF and EU COM, a new budget commissioner appointed by the Eurogroup would help implementing reforms. The commissioner will have broad surveillance competences over public expenditure and a veto right against budget decisions not in line with the set budgetary targets and the rule giving priority to debt service.” Greece has to ensure that the new surveillance mechanism is fully enshrined in national law, preferably through constitutional amendment.

As someone who has worked with over 20 governments and Ministries of Finance – and therefore a certain amount of operational knowledge on fiscal positions - I cannot recall even developing and aid-dependent countries being asked to, in effect, delegate its fiscal sovereignty to this extent – although policy conditionality can be tough – and where it is, it is in effect requested and signed-off  by the country.

And needless to say the initial reaction from Athens has been vociferously negative.

Moving on from basic economics to slightly more advanced stuff, lets take a leaf out of Game Theory…..

i.                     Is  Germany, which is clearly behind this initiative – given the blueprint in action of the Fiscal Compact – willing to take this to the limit? Does it expect Greece to comply, get the funds and thereby help placate German public opinion (which is against handouts to Greece) and then in future take charge through the implementing arrangements being put in place, or
ii.                   Are the Greeks being pushed to exit the Eurozone…if yes game over
iii.               Lets go to time period 2: Assume the Greeks bite the Bratwurst…sorry the bullet…and agree to the deal and then renege…what happens………yup, back in the Twilight Zone!
iv.            Introduce dynamics…Portugal sees what’s happening (Miguel look forward to  your views!), then the Cypriots, Irish,…Spain…and why not those peddlesome new Member States that never really sorted out basic corruption issues…say the Bulgarians or the Romanians….hmm how about the French while we’re at it. Will the other sovereigns in the firing line or those reliant on EU aid transfers within the expanded EU start to put up a coalition of resistence towards greater fiscal co-ordination or sign-up?

As far as Greece is concerned, there have to be grave doubts about the democratic legitimacy of the proposal but I can see a watered down version waived through in the EU-language of solidarity and partnership that allows  both Germany and Greece to get their desire. However, we’ll not be much further down the road from answering whether the entire process is credible – where I started or if we’re anywhere nearer a resolution of the Euro-Crisis.

From the donor side – and this is an apt term as Greece in effect aid dependent – there is a real (and understandable) concern about how to introduce a clear incentive-based approach that binds Athens to structural adjustment – however painful, and that if sustained lead to a sense of “revelation” for Greeks sometime in the next few years.

What is clear is that the fiscal measures agreed are not working so far. 

Sales of assets to raise €50bn? The original timeline of 2015 was stretched to 2017 but aside from the risk of achieving firesale prices or low value as far as the Greek tax-payer is concerned, there is a paradox in play – the Greeks need to sell but the fear of “Drachma-sation” and de facto devaluation in Greece (with a likely dose of high inflation) is putting off potential buyers. By corollary, the more the markets feel that Greece can stick the course  the more likely that the risk of drachma-sation will recede and appetite pick up.
So what we’re left with is …further budget cuts in the offing…including a further to-be programmed cut of 1% in the budget outlay in 2012.

Conclusions:

i.                     A bit like the end of the transfer-deadline today for football in England, gamesmanship means leaving things till the 11th if not 12th hour.
ii.                   A Greek default is not in anyone’s interests in the Eurozone or in the wider EU. The PSI settlement will be followed by some fudged-compromise agreement to the new conditionality and subsequent disbursement of a new €130bn tranche. And (back to Game Theory) the Greeks know this, the Germans know this, the Greeks know the Germans know this...the Germans know that the Greeks know that the Germans know this...hmm do the Scottish Nationalists know this ? :)
iii.                  Greece will meet the March 20th deadline for meeting the next debt payment of €14.4bn
iv.                 Expect increased vigilance at the Eurozone level of Greek budget programming and implementation….no bad thing in terms of broader governance for the Greek taxpayer…
v.                   …expanding over to the other sovereigns who, like Oliver Twist,  come round asking for more.
vi.                 Does it solve the economic collapse in Greece…No…so back to Oliver Twist we all need more...and more means a co-ordinated response for "more growth please!"
vii.                Will the risk on Greece meeting future debt repayments decline? Difficult to say at this stage: possibly, but push-come-shove  and Greece could still default in the future although the starting conditions will be significantly improved….
viii.              What it may do is to increase a typically iterative EU advance towards a fiscal Union through pooling of resources – cross-country collateralisation of debt issuance or Eurowide bonds. It may also as a consequence lead to a clear segmentation of countries within the Eurozone towards comparable zones…hmm wasn’t that the DM-zone before?

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