By Alen Mattich, Wall Street Journal
With each passing day, the prospect for a Greek default grows and, thus, the risk of a Greek exit from the euro. The timing’s so tight that even Christine Lagarde, head of the International Monetary Fund, one of Greece’s trio of international rescuers/creditors, reportedly acknowledged that the country could end up having to leave the single currency.
Whether Mrs. Lagarde’s purported warning is sincere or a means of urging Greece to hasten its negotiations is unclear. Whichever path it chooses, or is forced to take, Greece’s Syriza government will end up with exactly what it has campaigned so hard against: austerity. Because whether it capitulates in its negotiations or not, Greece has some more belt tightening ahead. In fact, over the near term, austerity within the eurozone would probably be considerably less severe than austerity out of it.
Here’s why.
Greek government finances are expected to fall some €1.8 billion ($1.97 billion) short of target this year, according to a Deutsche Bank research report. Earlier this year, the European Commission expected Greece to run a budget surplus of 1.1% of GDP this year. In May it cut this forecast to a deficit of 2.1%. Now, part of that drop is an acknowledgement that the Greek economy continues to struggle. Greece’s revised first quarter national accounts showed a 0.2% contraction on the previous quarter. Undoubtedly, political uncertainty is weighing heavily on consumers and business and the economy’s prospects aren’t great.
A bigger part of the problem, though, has been the Syriza government’s inability to get to grips with public finances, beyond temporary emergency measures. Indeed, the European Commission now figures Greece will run a cyclically adjusted surplus–which is to say excluding the effects of below-trend economic growth and high unemployment–of 1% of GDP this year. In February, it had been expecting a surplus worth 4.1% of a substantially bigger total national output (GDP growth projections have also been drastically reduced).
So far, the Syriza government’s proposals have been to close only some €500 million of that budget gap–through value-added tax increases. Not enough, say its creditors.
It seems almost certain that for Syriza to get a deal, it will have to make a better show of tax rises and spending cuts than it has been proposing. Austerity in other words.
Some have argued that since Greece has been running a primary surplus–which is to say that, excluding interest payments, the government’s revenues exceed its outgoings–Syriza should default on its debts. After all, one of the reasons not to default is because defaulting countries tend to be shut out of international credit markets. But Greece is already shut out of the markets. And if the Greek government is already covering its expenses apart from interest payments, why not just dump debt that no one really expects will ever be paid back anyway. What’s more, capital markets are so forgiving–or forgetful–that Greece would probably be able to tap them again in a few years’ time.
There are two flaws with this argument. First, Greece may be locked out of the capital markets but it’s still getting funding from abroad. Namely, European Central Bank emergency liquidity assistance to its banks, which have been suffering depositor flight. Should Greece default on its IMF obligations, there’s a good chance the ECB would cut off this funding. Greek banks would then almost certainly be hit by a banking crisis. The government would then have to respond with capital controls–limiting how much money people could take out of the banks and out of the country.
This leads to the second problem. A banking panic and capital controls would weigh heavily on the economy. Growth would take another hit–by some estimates the Greek economy would shrink by another fifth or so if it ends up being forced out of the euro. Falling GDP would mean falling government revenues which would force it to cut spending and raise taxes. In other words, austerity. Except this austerity would be even worse than the creditor-imposed belt tightening.
True, Greece could well eventually do better outside of the euro’s straitjacket than within it. But economic carnage lies between here and there, the scale of which no government other than a dictatorship could survive.
If, then, all roads lead to austerity, Syriza would do better to stay in the eurozone than try to operate outside of it. Which is maybe what Mrs. Lagarde was hinting at in a roundabout way.
