Greece: A Credible Deal Will Require Difficult Decisions By All Sides

blanchBy Olivier Blanchard

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The status of negotiations between Greece and its official creditors – the European Commission, the ECB and the IMF – dominated headlines last week.  At the core of the negotiations is a simple question: How much of an adjustment has to be made by Greece, how much has to be made by its official creditors?

In the program agreed in 2012 by Greece with its European partners, the answer was:   Greece was to generate enough of a primary surplus to limit its indebtedness.  It also agreed to a number of reforms which should lead to higher growth.  In consideration, and subject to Greek implementation of the program, European creditors were to provide the needed financing, and provide debt relief if debt exceeded 120% by the end of the decade.

The primary surplus in the program was to be 3% in 2015, and 4.5% next year.   Economic and political developments have made this an unattainable goal, and the target clearly must be decreased.   It also included a number of reforms aimed at increasing medium term growth, and making the fiscal adjustment easier.   These also need to be reconsidered.

In this context, by how much should the primary surplus target be reduced?  A lower target leads to a less painful fiscal and economic adjustment for Greece. But it also leads to a need for more external official financing, and a commitment to more debt relief on the part of the European creditor countries.  Just as there is a limit to what Greece can do, there is a limit to how much financing and debt relief official creditors are willing and realistically able to provide given that they have their own taxpayers to consider.

How should the initial set of reforms be reassessed?  Greek citizens, through a democratic process, have indicated that there were some reforms they do not want. We believe that these reforms are needed, and that, absent these reforms, Greece will not be able to sustain steady growth, and the burden of debt will become even higher. Here again, there is a trade off:  To the extent that the pace of reform is slower, creditors will have to provide more debt relief.  Here again, there is a clear limit to what they are willing to do.

The offer made to the Greek government last week reflected these considerations and these tradeoffs.  It proposed to lower the medium term primary budget surplus target from 4.5% of GDP to 3.5%, and give Greece two more years to achieve that target---so the target for this year was reduced to 1%---and it asked for a more limited set of reforms.

For a deal along these lines to be effective and credible however, two conditions must be satisfied.

On the one hand, the Greek government has to offer truly credible measures to reach the lower target budget surplus, and it has to show its commitment to the more limited set of reforms.  We believe that even the lower new target cannot be credibly achieved without a comprehensive reform of the value-added tax (VAT) – involving a widening of its base – and a further adjustment of pensions.  Why insist on pensions? Pensions and wages account for about 75% of primary spending; the other 25% have already been cut to the bone.  Pension expenditures account for over 16% of GDP, and transfers from the budget to the pension system are close to 10% of GDP.  We believe a reduction of pension expenditures of 1% of GDP (out of 16%) is needed, and that it can be done while protecting the poorest pensioners.  We are open to alternative ways for designing both the VAT and the pension reforms, but these alternatives have to add up and deliver the required fiscal adjustment.

On the other hand, the European creditors would have to agree to significant additional financing, and to debt relief sufficient to maintain debt sustainability.We believe that, under the existing proposal, debt relief can be achieved through a long rescheduling of debt payments at low interest rates.  Any further decrease in the primary surplus target, now or later, would probably require, however, haircuts.

These are tough choices, and tough commitments to be made on both sides.  We hope that agreement can be achieved along these lines.

2019-03-27T16:02:04-05:00June 14, 2015|

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  1. Paul Wilson June 14, 2015 at 5:06 pm

    The trouble with this Blog is that it pretends there are clear answers to questions which most economists understand are highly debatable. Is 120% of GDP really an important debt level threshold? Obviously not – if the EZ nations want to provide Greece with cheap, long term financing, then Greece could safely run much higher debt levels. Have the Greeks really cut all spending except pensions and wages “to the bone”, so now pensions must be cut? Surely the IMF should let Greeks decide, and not assert their own cuts. With unemployment at 26%, should we be asking Greece to cut another $2 billion from their spending just to reach a 1% primary surplus instead of 0%? This Blog merely asserts 1% is the right number – that is surely wrong too. If Greece can’t grow, they will default. If they can grow, they will probably avoid default. Small cuts for a couple years are neither here nor there – getting unemployment down and growth up is the first priority. The Blog should mention that long term pension reforms are critical, and so are policies which promote business growth and jobs. Instead, this debate has become a cacophony of arguments where even the major participants know their assertions lack substance. Eventually Merkel and Tsipras will sit down and decide on terms. Then, the IMF will be told by Obama to agree, and soon the IMF will write a new Blog about how sensible THOSE new numbers are too.

  2. Rob P June 14, 2015 at 5:53 pm

    So the decreases in target primary surpluses that the EU/ECB/IMF have “offered” can all be dealt with through rescheduling and low interest rates, but to allow the primary surplus in 2015 to be lowered from 1% to 0.75% would be such a massive burden that haircuts would have to occur? I don’t buy it. The “partners” have chosen some nice, round numbers e.g. 1% and now are trying to justify refusing even an additional quarter percent movement.

  3. Pantelis Michalopoulos June 14, 2015 at 6:41 pm

    Dear Mr. Blanchard: you say that government costs other than pensions and wages have already been cut to the bone, and therefore it becomes necessary to inflict pensions. What about military expense cuts? Why are these not adequate substitutes for pension cuts? Is it true that the Fund rejected the substitution of one for the other, as reported? If so, why? Best regards Pantelis Michalopoulos

  4. Aart van der Wal June 15, 2015 at 1:46 am

    A clear picture, and open minded as well. The moment of truth has finally arrived. EU governments have to waive their pretensions and tell the truth to their tax payers.

  5. Pepi Tataki June 15, 2015 at 6:21 am

    Hello. You write in your post that “transfers from the budget to the pension system are close to 10% of GDP”. Based on the 2015 Greek Budget, €18.7bn is the amount projected for both salaries and pensions, which is around 10% of GDP. I think that the percentage is lower than the one that you are mentioning.


  6. margaretbowker June 15, 2015 at 6:25 am

    Olivier Blanchard’s last two paragraphs were encouraging. It wasn’t entirely clear in the first, whether the referred to alternative ways for designing savings and extra income in the VAT (tourism as well?) and pensions areas, included reducing elsewhere, so that the figures added up to get that 1% primary surplus. The second paragraph was nice and clear and referred to debt relief, which in practical terms, means rescheduling with very low interest rates, for me the sort that are hardly there, and extremely long terms. Is it too much to hope for some debt-forgiveness? I thought the negotiation was going to get somewhere yesterday, all eyes now on Thursday.

  7. Marc Kaptijn (@marctrompet) June 15, 2015 at 6:34 am

    If Greece manage to grow the economy and reduce unemployment wouldn’t that reduce the expendeture of pensions as a % of GDP? Wouldn’t that be much more effective? In stead if you increase VAT and cut pensions overall by 25%, how do you think the economy in Greece could ever grow?

    Instead the Troika should slash demands for further austerity and work with the Greek goverment in order to build up the economy. And then only then do you have the possibility to resolve the debtcrisis and reform the Greek economy (including the pensionsystem) in a more sustainable manner.

  8. sirop June 15, 2015 at 7:24 am

    Hallo, Mr. Blanchard.

    Thanks a lot for your estimates.

    May I ask you for one more estimate?

    You clearly state that the divergence between the Greek and the Troika proposals will have to be paid by European creditors. But how big is this divergence in terms of billions of euros? For instance annually until 2018?

    Thanks in advance for your answer.

  9. davidmsteele June 15, 2015 at 7:25 am

    When you say ” We believe a reduction of pension expenditures of 1% of GDP (out of 16%) is needed, and that it can be done while protecting the poorest pensioners”, what would that mean pensioners would be living on per month? The Guardian UK reports that “Nearly 45% of Greece’s 2.5 million retirees now live on incomes of less than €665 a month – below the poverty line defined by the EU”. Pension cuts can hardly be justified in such circumstances.

  10. Henderson Claude June 15, 2015 at 9:09 am

    The problem with this argument is that it’s simply economically irrational over the long term for Greece to stay in the euro, deal or no deal. Moreover, “Europe” has demonstrated clearly that it is willing to impose developing country conditions on a peripheral state in order to protect first German and French banks, and then the Taxpayers who backstopped them. So much for a United States of Europe. So why on earth should the Greeks not cut their losses, get out and start over? Within a few years they will be better off than grinding out twenty years of austerity. They are afraid, but sooner or later national interests will prevail.

  11. Paul Temperton June 16, 2015 at 3:15 am

    An excellent summary of the position. If only the media coverage were as clear!

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