Greek Myth, Greek Reality

Image: Bloomberg

There is a famous Greek myth about two sea monsters, Scylla and Charybdis. It is said that they lived on opposite ends of the Strait of Messina, terrorising ships that attempted to pass. If any vessel attempted to avoid one of the monsters, it was certain to be destroyed by the other. Today, that legend is encapsulated in the saying "between a rock and a hard place." 

Athens now finds itself in a somewhat analogous predicament. By the end of this month, Greece must repay the International Monetary Fund (IMF) $1.7 billion in loans. Additionally, in July and August the country is due to pay the European Central Bank (ECB) nearly 6.8 billion euros ($7.6 billion). Greece does not have the funds to honour those obligations. Crucially, the European Commission is refusing to release 7.2 billion euros in bailout funds unless the Greeks agree to additional fiscal austerity measures. If Greece is unable to repay its debts, it faces expulsion from the euro zone, a scenario commonly referred to as "Grexit". 

This is where Greek Prime Minister Alexis Tsipiras, and his Finance Minister Yanis Varoufakis, face a real conundrum. Exasperated Greeks elected the left-wing Syriza party in January on an anti-austerity mandate. However, Greece's European creditors are demanding tough concessions, which include cutting pensions and raising taxes. Tsipiras has voiced strong displeasure at this proposal. For him to capitulate and agree to the loan conditions would be political suicide. Hardliners within Syriza would abandon the government, potentially forcing a fresh election to be called. Further, the spending cuts required by the agreement threaten to deepen the country's economic woes. Austerity measures weigh on growth and are likely to extend Greece's protracted recession, a proposition the Greek people can ill afford. 

Unfortunately, the other option is hardly enticing. Should Athens reject their creditors' proposal, the consequences could be calamitous. Deposits would flee from Greek banks and emergency liquidity from the ECB would no longer be available, precipitating a liquidity crisis that could push financial institutions, and the government, into a default. Capital controls would have to be implemented, and Greece would effectively be forced out of the euro zone. The country would have to return to the drachma, its previous currency. This, coupled with an already crippled economy, would result in immediate devaluation of the drachma, leading to inflation and an extended economic crisis. 

With talks currently at an impasse, and neither side willing compromise further, there is little hope that common ground will be found any time soon. Within the creditor countries, led by Germany, there is political appetite to extend more financial assistance to Greece is scarce. Voters have grown weary of the bailout packages. Tellingly, the most recent round of negotiations, on Sunday, broke down after just 45 minutes. 

Tsipiras and Varoufakis must choose their monster. Although not politically palatable, the sensible option is for Greece to accept the European Commission's proposal. It is in Greece's benefit to stick with the euro, and whilst few Greeks would support austerity measures, the majority do indeed want to remain within the eurozone. Currently, there appears to be no happy ending to this story, but a default by Greece would be far more damaging than the alternative.

With that in mind, it is also worth noting that the Greek government has more leverage in negotiations than may initially be apparent. European politicians frequently claim that a "Grexit" would be economically manageable. This is imprudent. Should Greece leave the euro, the ECB will face large losses on its loans to the country, and market contagion is a serious possibility if spooked investors pull capital out of the EU. Growth throughout the region may be hampered. It is in everyone's interests to see Greece pay off its debts.

Above all, it is critical for the European Commission to recognise that the problems with Greece's economy are systemic. The process of hammering out an agreement to resolve short term debt obligations must not mask the need to remedy Greece's economic malaise. Athens' debt obligations total 320 billion euros, a colossal 175% of national output. Repeats of the current dept repayment crisis are inevitable unless a long term solution can be found.

Greece's creditors are demanding that the country maintain a primary surplus of 3.5% of GDP, an entirely unrealistic number. Maintaining such a budget surplus will require strict fiscal belt-tightening measures, which, by nature, crimp growth. Instead of prolonging the current economic pain, the European Commission must rethink its strategy regarding Greece and develop proposals that will allow the Greek economy to return to a path of mutually beneficial growth. Of course, it is undeniable that Greece needs economic reforms. The Greek government certainly must find a way to rein in wasteful spending and implement changes in the pension system and labor market.

Ruin was inevitable for ships that attempted to pass between Scylla and Charybdis. However, fiscal catastrophe should not be a foregone conclusion for Greece. Sensible concessions and reforms can avert the worst outcomes, though not even an optimist would doubt that Greece will face further economic hardship before the situations turns for the better.