Thursday, November 18, 2010

Five Myths About the Greek Crisis

Greece is in a tough spot. No doubt about that. But not all the things said about Greece are true. Here are five myths about the Greek crisis.

Myth #1 is that the Greek taxpayer would be instantly better off if the country defaulted or restructured its debt. In fact, Greece is running a primary deficit in 2010 and 2011, so even if it spent no money on debt service, it would need to cut spending or raise taxes by more than it is currently doing in order to balance its budget. Only after 2012 does a default mean that the Greeks can spend more by not having to service debt (see here).

Myth #2 is that the Greek economy is derailing beyond expectation. In fact, the economy is shrinking at precisely the level that the Greek government and IMF forecasted it would when it lent money to Greece in May 2010. A 4% GDP reduction was expected for 2010 and the economy so far in 2010 has contracted by 3.7%. This is unpleasant, but it is not unforeseen (see here). And the program assumes it will get worse, forecasting a 2.6% GDP drop in 2011.

Myth #3 is that rising spreads on Greek bonds are a problem. The spreads on Greek bonds versus German bonds remain high and have risen lately. But these spreads have no immediate impact on finances (since Greece is not borrowing money at long maturities) and they are also the result of very low liquidity. So they do not say much about Greece at all (see here).

Myth #4 is that Greece is missing wildly its targets. In May 2010, the Greek government committed to reduce its budget deficit from €30.882 billion in 2009 to €18.691 in 2010, a 39.5% reduction. In the latest (October) budget execution bulletin, the government said that the deficit would reach €19.473 billion in 2010, which is a 36.9% reduction (see here). The revised deficit and debt numbers are going to make what is needed going forward greater, but this is a swing of more than €10 billion. This is huge progress and just below what was expected. Even the IMF noted that, “the program has made a strong start.”

Myth #5 is that because Greece ends the IMF program with a debt that is higher than it is today, this proves that Greek debt levels are unsustainable. Hardly. Greece ends up the program with a higher debt level than when it started – this is true and this is the nature of a country that is undergoing a fiscal consolidation that cannot happen overnight. Since the country needs to keep running deficits, its debt will rise.

But whether this means that Greece’s debt is unsustainable is another question. Whether Greece defaults is not a function of whether Greek debt will be 144% or 150% or 160% of GDP. Rather, whether Greece defaults will depend on (a) whether the reforms underway have taken root and (b) whether markets have an appetite for riskier bonds. In fact, if the latter is true, Greece could get off the hook even without the former.

1 comment:

  1. You write:

    "Whether Greece defaults is not a function of whether Greek debt will be 144% or 150% or 160% of GDP. Rather, whether Greece defaults will depend on (a) whether the reforms underway have taken root and (b) whether markets have an appetite for riskier bonds. In fact, if the latter is true, Greece could get off the hook even without the former."

    I would add: (c) whether intervention by other countries in the market for Greek debt securities is sustained.

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