17 June 2015

Bruegel: Greece – the three essential elements for a deal

Stances on both sides in the Greek negotiations have hardened, and creditors and debtor still seem far away from each other. In this blog, I charter the three elements that are crucial for a deal. They concern the primary surplus, how to deal with the debt and, most importantly, confidence and trust in a monetary union.

First, on the fiscal target debate, the creditors are requesting a primary budget surplus (revenues less expenses without interest rate payments) of 1 % of GDP this year, 2 % next year, and 3 % in 2017, rising to 3.5% by 2018. Syriza, in contrast, is asking for a more modest adjustment of up to 0.75% this year, 1.75% in 2016 and 2.5% in 2017. Accumulating these fiscal paths over 2015-18, the difference between the two amounts to 1.0% more of GDP requested from the creditors. By any metrics, this difference is substantial regarding its impact on GDP, but rather irrelevant compared to the overall debt burden. In fact, the literature is rather clear that in a recessionary environment, a fiscal adjustment of 1% of GDP per year will lead to GDP losses of even more than 1%. After a decline in GDP of more than 25%, Greece has a point in calling for lower primary surpluses.  

The second issue concerns the level of public debt. International commentators and academics have been calling for debt relief to Greece.  A number of interrelated aspects need consideration in this regard.

• Do high debt levels demand high primary surpluses, which in turn hurt growth and are politically unachievable? Syriza and the creditors seem to agree on a primary surplus of 3.5% from 2018 onwards. However, we know from Eichengreen and Panizza that such high primary surpluses rarely occur for an extended period of time and come with high political and economic costs. Arguably, such high primary surpluses are not really necessary. Take for instance a significantly lower primary surplus of only 2.5% and different assumptions as regards inflation and growth (base scenario: 3.7% nominal growth, pessimistic scenario: 2% nominal growth, the average interest rate is set at 3.7% and derived from forward rates, for details see Darvas and Hüttl). Even in the pessimistic scenario that only assumes 2% nominal growth, the Greek debt to GDP ratio would still fall, although at a slower pace (see figure). A slower reduction in the debt to GDP ratio requires either access to the market so that Greece can pay its official creditors on time, or delayed re-payments of official creditor loans, which would de facto amount to some debt relief. Since Greece almost regained market access last year, arguably it will be able to start EU re-payments with access to markets as of 2020. And certainly, a debt-to-GDP ratio in 2030 of 115% could be compatible with market access just as well as a debt-to-GDP ratio of 105%.  

Full article (with charts)

© Bruegel