13 Jul 2015 08:13

Greece, Europe and the future – where are we headed?

The Eurozone leaders reached an agreement. Greece has taken a step back from the abyss and from a severe economic collapse, but both Greece and the euro zone face continued major challenges. The euro crisis of the past six months will leave behind wounds that are not only difficult to heal, but also permanent scars, comments SEB´s chief economist Robert Bergqvist.

Greece has taken a step back from the abyss and from a severe economic collapse, but both Greece and the euro zone face continued major challenges. For the Greeks, the path forward will begin with an uphill climb. Meanwhile Germany is wondering whether the economic costs of the euro project are reasonable compared to the political benefits. The euro crisis of the past six months will leave behind wounds that are not only difficult to heal, but also permanent scars.

Agreement reached at five past twelve 

Greece and the troika – the European Commission, European Central Bank (ECB) and International Monetary Fund (IMF) – have agreed to begin formal bail-out loan negotiations. There is also a “framework” for a third Greek crisis programme (see below). 

Greece was a hair’s breadth away from plunging over the edge of an economic cliff. In the end, the outcome of the discussions was determined by trust, acknowledgement of problems by Greek political leaders, major German political concessions and global security considerations. Unfortunately there is nothing in this past weekend’s agreements, or in the way the crisis has been handled, that gives reason for political pride or for easing concerns about the future of the euro project and the European Union.

Greece’s third bail-out package – the agreement

Greece is being offered: A three-year loan of more than EUR 80 billion including capital aid to its banks. In addition, Greece is being granted a debt restructuring – but no write-offs (“haircut”) – which in practice will mean an extension of loan maturities.   

In return, Greece is enacting: Cost-cutting and revenue enhancements of about EUR 12 billion over two years, including more uniform value-added tax, higher taxes on shipping, cutbacks in pension benefits, defence cuts and privatisations. Greece also undertakes to implement these policies quickly and allow increased access to various government ministries by troika representatives.

As the dust settles, three conclusions are apparent:
  • The bill remains unpaid for the euro zone’s built-in economic, financial and political weaknesses;
  • The choices are clear: political union and greater integration or continued instability and recurring crises;  
  • Leaving the EU currency union is possible, since it has been officially discussed as an alternative for Greece. 

Further details will now be added to the overall package, which must win support in several national parliaments. So we have taken vital steps forward but are not yet at the goal.

Greece’s path will begin with an uphill climb

The Greek government has very little time to regain the confidence of its own people (stopping the bleeding from Greek banks), its euro zone colleagues (normalising relations) and other countries, including IMF members. Greece may be fully financed for three years, but this does not mean Athens can relax; the bail-out programme will be evaluated continuously. Any deviations from Greece’s promises will mean bail-out payments can be suspended.

With all due respect for the strains that Greeks have had to endure − and will endure − international distrust of the Athens government has grown in the past five years for good reason, swelling to the breaking point in recent weeks. As early as 2010, the Greek economy was rapidly headed towards the brink of collapse. Three bail-out packages (and over EUR 300 billion) later, after a 2012 write-off of over EUR 100 billion in private debts, the cost of saving Greece has obviously grown. Meanwhile we have seen Greek governments partly or entirely abstain from implementing the promised structural reforms that are necessary.

Last weekend 251 (out of 300) members of the Greek parliament voted for the government’s emergency budget. This is a clearly positive signal that Greece is acknowledging the crisis. It decreases the risk of political instability, at least in the short term, represents a level of political support we have not seen in the past five years and allows cautious hope for the future. A cabinet reshuffle is now likely in Greece.  

The Greek economy has been damaged by the domestic political events of the past six months and by the closure of the banking system. Capital controls are likely to persist in some form; in Cyprus, they lasted two years. Lower purchasing power may well push down short-term economic growth, although renewed optimism and lower interest rates will improve growth prospects. The government will have a difficult task trying to persuade the Greeks that the path it has chosen is the only one that can reverse negative trends.

Greece’s Alexis Tsipras – a short-term winner

Prime Minister Tsipras’ actions have been surprising. They are either the outcome of a carefully conceived strategy or – more likely – a reflection of his lack of political experience in leading a party and government and participating in international crisis negotiations. But at least in the short term, Tsipras has undoubtedly strengthened his position. By winning strong public backing in the July 5 referendum, he gained a mandate from the Greeks to pursue a hard line against other countries that indirectly tried to weaken him on his home front. He got extra time to gather support for his proposals. Meanwhile his political position has been strengthened by the opposition’s weakness. Tsipras’ political future will be determined by the number of dissenters in his own party and by whether the economy can relatively quickly begin to show signs of improvement. But if voters only view the bail-out pact as a capitulation, new political problems await him.

Germany’s Angela Merkel – a long-term loser

The chancellor finally ended up in an impossible situation: either help trigger a historic decision that forces an EU/euro zone country into bankruptcy, or open Germany’s wallet again and pay for something that has not shown the desired results so far. A consistent theme of Germany’s actions during the euro zone crisis has been that increased financial aid to various countries must go hand in hand with efforts to achieve greater integration and, in practice, less economic policy independence. At present, the winds of federalism are weak and it is becoming increasingly hard to demand tough responses from individual countries.

As the largest EU and euro zone country, Germany has thus been forced to supply more money than anyone else, without guarantees of getting anything in return. Though the idea still seems remote, there is a growing risk that public opinion in Germany will shift towards exiting the euro zone (“Dexit”). But this would require the economic costs of the Greek bail-out to exceed its political benefits.

US intervention in the crisis was another crucial factor in persuading Ms Merkel to agree to a new rescue package. Conspiracy theorists argue that, in the midst of the crisis talks, the United States persuaded the IMF to publish its Greek debt analysis early to help achieve a quick agreement. The US fears that Greece’s problems may add to the heightened political instability that has existed in the vicinity (the Middle East, Turkey, the Balkans etc.) for some time. 

Intervening in national sovereignty – new norm?

In an environment where anti-austerity policies are gaining more and more popular support, last weekend’s agreement is expected to embolden populist forces not only in Greece but in other economically challenged euro zone countries. There may be calls for referendums like the one in Greece.

Critics may argue that the EU has gone too far in trying to influence political events in one country and that in practice, it is seizing the role of guardian over Greece’s economic policy makers. Others will argue that this is something that we must start getting used to. If the euro zone is to achieve long-term stability, its 19 member countries will need to move towards greater federalism, a more supranational system, expanded common fiscal (transfer) policies and thus reduced economic policy independence at the national level.

A changed view of the EU currency union

Now that Greece’s euro zone and EU membership seems to have been saved – at least in the short term – Pandora’s box has been opened. The concept of “Grexit” has become well established, and EU representatives even declared that they had a detailed plan for a possible Greek exit from the euro. Today Greece argues – probably correctly – that EU treaties do not allow its withdrawal from the euro zone. That conclusion was indirectly confirmed by Germany’s suggestions that Greece take a “time-out” from the euro project and launch a two-currency system (stay in the euro zone, but…). If we conclude that admission to the EU’s currency zone is not a one-way ticket − but perhaps a return ticket – this implies that from now on, all euro zone countries should carry various currency risk premiums.

The ECB on a political leash

During the Greek crisis, the ECB has been forced to abstain from making non-political assessments of credit risks when lending. Greece’s failure to pay the IMF on June 30 was a confirmation of a technical default and should have forced the withdrawal of the ECB’s emergency liquidity aid loan of EUR 90 billion. This did not happen – which is politically understandable yet illogical.

The ECB’s aggressive monetary policies have been desirable as a way of preventing inflation expectations from falling. They have also enabled individual countries to play a high-stakes political game. Large-scale purchases of securities have disabled signalling systems, placing individual countries in a kind of fictitious safety incubator, with almost unlimited funding – despite obvious credibility problems. 

Major political challenges ahead

The 2015 “version” of the Greek crisis has been the worst so far. It has shaken the EU’s currency zone to its core. Greece has been teetering on the brink of an economic abyss.

One thing is 100 per cent certain: this is not the last euro crisis that Europe and the world will see. To achieve lasting stability, the euro project needs three more “pillars”:

  • Fiscal union (transfer union); 
  • Economic policy union;
  • New democratic but supranational political infrastructure.

Europe lacks visionary political leadership. The potential for deeper EU and euro zone cooperation and integration is being undermined by high unemployment, economic policies handicapped by record-high debts and large refugee flows. The United Kingdom is pushing to revise existing EU treaties as a condition of remaining in the EU. German-French relations have recently worsened. There is a substantial risk that populist parties will want to follow Greece’s example and gain new benefits. The challenges of keeping the euro zone and the EU together in the future will grow.

In Greece’s case, the ink has not yet dried on the signatures under the latest agreement. There are many indications that the latest crisis package is still insufficient in light of underlying structural weaknesses in the Greek economy. The pressure on Greece and on the Athens government will be intense for a long time to come.