25 May 2016

What has been agreed?

You can find the Eurogroup statement here and the press release here which spell out the key points of the agreement.

Essentially the first review of the third Greek bailout is now completed and the funds – €10.3bn in total, €7.5bn in June – can now be released. This means Greece will avoid any extended funding dramas this summer and will be able to repay the maturing bonds held by the ECB (as always expected).

More interesting, is that there was a broader agreement on debt relief, though this mostly involved delaying the key decisions until 2018 – after the current bailout is completed. The key points are:

  • Short term – use funding tools available to smooth Greece interest payments on Eurozone bailout loans.
  • Medium term – after 2018 provide greater debt relief via some combination of: extending the maturity of Greek bailout loans, repaying profits on bonds held by the ECB to Greece and buying out the more expensive IMF loans using leftover funds from the bailout. Keep Greece funding needs under 15% of GDP per year.
  • Long term – consider further steps to help Greece keep funding needs under 20% GDP per year. May create mechanism where these kick in automatically if funding need rises above threshold.

How much debt relief will this actually deliver for Greece?

This is hard to say exactly since the promises remain pretty vague and the big decisions have been delayed until 2018. The short term movements seem largely irrelevant. It’s not obvious why these wouldn’t have happened anyway (since they often related to keeping EFSF/ESM funding costs low), while much of the debt maturing over the next few years is from the ECB and IMF not the Eurozone bailout funds.

In terms of options for medium term debt relief, they could provide quite significant cuts if the maturity extensions are for decades. The same goes for deferring or capping interest payments. That said, we know from previous discussions that the Eurozone is hesitant to go as far as the IMF on these issues (more on this below). Repaying ECB profits will provide a nice injection of cash and a slight reduction in the headline debt burden but is unlikely to make a big material difference. Buying out IMF loans could be useful as these are more expensive and mature earlier. However, there seems something strange about pushing to have the IMF involved in funding the third bailout only to then buy it out a couple of years later.

IMF seems to have capitulated once again

Speaking of the IMF, the biggest implication of this deal could be that it has capitulated to Eurozone demands once again. First, a caveat – while the Eurogroup has suggested the IMF will be involved and IMF Europe Director Poul Thomsen has supported the deal, this is all still subject to approval from the IMF Board of Directors. As such, it’s possible the IMF may yet fail to agree on a new financing package for Greece. Nevertheless, the fact it is looking as if it will, could be another hit to the fund’s credibility. It is hard to see how the deal outlined by the Eurogroup fits with the recent Debt Sustainability Analysis (DSA) published by the IMF. It falls short on a number of points:

  1. Keeps the primary surplus target for Greece over the long run at 3.5% of GDP rather than the 1.5% demanded by the IMF. The IMF labelled this target “unrealistic” and highlighted that “few countries have managed to reach and sustain such high levels of primary balance for a decade or more”.
  2. Does not involve substantial and “upfront” debt relief as demanded by the IMF, but delays it until at least 2018. By definition debt relief is also not “unconditional” as the IMF wanted it to be, but dependent on implementation and completion of the current bailout programme.
  3. The threshold for Gross Financing Needs is set at 15% of GDP in the medium term and 20% in the longer run. However, the IMF said it should be below 10% up to 2040 and only rise to 20% in 2060.

IMF DSA 16 itemprop=

Broadly, looking at the graphs above (taken from the IMF DSA), it’s hard to see how this deal definitively puts Greece on the sustainable debt path. It may bring it closer compared to the current path, but it is still contingent on future action and measures which may only kick in if there is substantial drift from what the Eurozone sees as a sustainable path.

Can this help Greece “turn the corner” as claimed by the Greek government?

Greek Finance Minister Euclid Tsakalotos said that the agreement was an “important step” and that it could allow Greece to “turn the corner”. It’s hard to see how this is true. It essentially amounts to the minimum amount of debt relief that could have been expected given the agreement last summer. As noted above, the key decisions are delayed, the relief remains conditional and of course there are no nominal cuts. All in line with what the Eurozone would have wanted. Furthermore, the high primary surplus target means that there will be sustained pressure on Greece to maintain low levels of government spending over a sustained period and may need further cuts. It is far from clear there is the institutional capacity and political willingness (both at government and public level) to undertake this.

Furthermore, as the IMF pointed out, it’s hard to see where long term growth in Greece will come from. It faces an ageing and shrinking labour force while capital investment will remain constrained given low government spending and uncertain private investment. This means reforms and improvements to the business climate will play a big role in boosting productivity and growth – again it’s not clear Greece can achieve this at a sustained pace over the long run (to put it mildly).

Why have we ended up here again?

The fact that any kind of deal was reached is a bit of a surprise and highlights the desire to avoid another protracted crisis in Greece. This may well be linked to the UK’s EU referendum in that an unedifying spat would be seen as helping the Leave side. But other factors are also in play. It’s clear Germany and, maybe to a lesser extent France, don’t want to make any big decisions on Greek debt before their elections next year and don’t want to have to push any big debt relief packages through their parliaments. More broadly, it once again comes back to the basic agreement which was struck last year – keep Greece in the Eurozone but avoid taking the tougher decisions. As I’ve noted countless times before, the intractable problem of opposing democratic wills between Greece and Germany make this an incredibly difficult problem to solve. Of course at some point the chickens will come home to roost. In the meantime, the Greek economy and people are likely to pay the price.