Tuesday, 24 May 2011

Post-restructuring, which future for Greece?

The events around Greece and its government debt are taking new turns every day. It understandably has the financial markets on tenterhooks. A good deal of the commotion comes from the fact that more and more economists and market participants are trying to do the math, and they end up with more or less the same conclusion: No austerity policy will make it possible for Greece to repay its debt. In particular not when the austerity measures are meeting increasing resistance from the voters.

Some of the more sanguine observers have begun to make – not entirely unfounded – comparisons between Greece and Argentina. Two decades ago Argentina introduced a “currency board” whereby the currency was pegged to the USD in an attempt to control inflation. After an initial period where exports picked up strongly, the domestic economy floundered, unemployment increased, government deficits exploded, and the current account worsened. The government debt was largely sold abroad, where investors believed in the strength of the currency board.

However, in absence of serious reform, the government deficit continued growing, and servicing the debt meant a serious further strain on public finances, and even a wave of privatisations was insufficient. In 2001 the currency board evaporated, the currency depreciated by a whopping 70%, and in 2002 Argentina defaulted on the debt. It has taken nearly a decade of economic hardship to rebuild the economy and in 2010 Argentina offered to resume paying back the debt.  

There are some eerie similarities between Greece and Argentina. Most significantly, both entered into a very rigid currency regime with an economy that was clearly not ready for such a move. The ensuing drop in interest rates mainly led to an increase in property prices and consumption. The economy did not in any way undergo a development whereby investments were made in sectors that would increase the export competitiveness.

That is the main problem with Greece. No matter what happens to the Greek government debt (my guess: debt rescheduling, followed by a small haircut, eventually default), or Euro membership (my guess: will be maintained for now), in order for Greece to move forward, some serious structural reform is necessary.

The problem here is that “serious structural reform” has a meaning that not everybody likes. I may mean that established power concentrations will have to be dissolved, labour market conditions may have to be liberalised, public sector reformed, a serious privatisation programme will have to be introduced.

All of that will upset the existing status quo and that is usually not wanted. But since Greece’s exit from the
Euro is far away, such reforms will have to be more profound, since no currency devaluation will help the adjustment. I am afraid that the full weight of the necessary changes in the aftermath of a restructuring has not yet dawned on all parties.

It is interesting to see that the European consensus of “extending and pretending” is beginning to unravel. Whereas Germany is beginning to see the advantage in restructuring Greece’s debt while Spain and Italy have strongly denied that such a thing could happen. They are obviously afraid that they will stay out of the limelight as long as EU covers up for Greece. That position becomes increasingly untenable as time passes. 

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