RaboResearch - Economic Research

Is the Greek debt saga finally over?

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  • On 22 June, the Eurogroup agreed that Greece has passed the fourth and final review of its third financial support package
  • As a result, Greece will receive a further 15 billion euro loan and debt obligations on EFSF loans will be deferred by ten years
  • Accordingly, public debt payment difficulties are expected to be limited in the short run
  • Yet due to its high public debt, Greece stays dependent upon the mercy of Eurozone partners and the markets for a long time, amid an improving but still very weak economic environment

Is Greece ready to stand on its own feet?

On 22 June, the Eurogroup agreed that Greece has passed the fourth and final review of its third financial support package. As a result, Greece will receive another tranche of money from Europe and Eurozone partners have also agreed to alleviate the country’s debt burden. Moreover, the passage of the review implies that Greece will leave its current third financial support package by 20 August of this year, as planned.

In this Q&A we will explain what Greece will get in return for passing this fourth review, look at the strength of Greece’s public finances, share our economic outlook and most importantly, explain why we think the Greek debt saga has entered a rather quiet stage, but is not yet over.

In short, the upshot is that payment difficulties are expected to be limited in the short run, but due to its high public debt Greece stays dependent upon the mercy of Eurozone partners and the markets for a long time.

What does passing the fourth review yield?

In the next few weeks Greece will receive 15 billion euro from Europe: 5.5 billion euro can be used for upcoming debt obligations, while 9.5 billion euro will flow into an account to build up the government’s cash buffer. This brings the total cash buffer to 24 billion euro.

On top of the money transfer, Greece and its European creditors have agreed on a debt relief package, in order to keep gross annual financing needs below 15 percent of GDP in the upcoming years and below 20 percent in the longer term (figure 1). The most important elements of the package are that interest payments on 96 billion euro EFSF loans will be deferred by ten more years and that the average weighted maturity on those loans will again be extended by ten 10 years. It implies that Greece will only start repaying these loans from 2033, and the same goes for interest payments on these loans. Accordingly, debt repayments between 2023 and 2033 will be around 30 percent less than otherwise would have been the case (figure 2).

Finally, the Eurogroup has also approved two conditional debt measures. The first measure is that almost 6 billion euro (3.2 percent of GDP) of profits the Eurosystem has made on Greek debt holdings (related to the SMP and ANFA programmes) will be redistributed to Greece in bi-annual instalments until 2022. The second measure is that the step-up interest rate margin on a tranche of 11.3 billion euro in the second programme to buy back more expensive debt at the time, that would have become effective in 2018, will be waived (savings of about 200 million euro a year). To be eligible for these measures Greece needs to implement several reforms adopted and initiated under the current (ESM) support programme and run a primary surplus of 3.5 percent until 2022.

On top of the current debt relief measures, the Eurogroup has agreed that more will be done if needed to make sure gross financing needs remain below the 15 and 20 percent targets set. The European institutions will review the situation at the end of the grace period (2032) and in case of unexpected adverse growth, interest rate and/ or primary surplus shocks in the meantime. But only if Greece has adhered and adheres to European budget rules.

Figure 1: The IMF and the European Commission disagree over long-term financing needs
Figure 1: The IMF and the European Commission disagree over long-term financing needsNote: Updated IMF estimate is expected in Article IV 2018
Source: European Commission, Compliance Report ESM Stability Support Programme for Greece, Fourth Review, 23 June 2018. IMF Article IV Greece February 2017.
Figure 2: Repayment scheme Greek public debt (31 May 2017)
Figure 2: Repayment scheme Greek public debt (31 May 2017)Note: Owing to the new debt relief measures, the orange (EFSF) bars will move ten years to the right. The rather limited bond sales to private investors and bond swaps since May 2017 are not incorporated in the figure.
Source: Macrobond, Bloomberg, Rabobank

Have Greece’s debt problems been put to bed?

For the short to medium term the answer is yes, for the long term the answer is not yet.

Greece’s public debt is still stubbornly high at 179 percent of GDP. Many years of high growth and/ or budget surplus are required to reduce the country’s debt load and to make sure the country can actually go it alone. With a potential growth rate below one percent, it is unlikely the country can simply grow out of its debt.

On the bright side, Greece has been able to transform its very large (primary) budget deficit into a surplus (figure 3). In 2017, the government’s (primary) budget balance stood at (4.0) 0.7 percent compared to a deficit of (10) 15 percent in 2009. This clearly limits financing needs going forward. At the same time, rollover risks and debt servicing costs are lower than should be expected based on the debt to GDP ratio. As much as 86 percent of total public debt is currently held by official institutions, like the IMF, central banks and European financial support facilities (EFSF and ESM) (figure 4). These official institutions have lent Greece money at rather favourable rates and tend to be less footloose than private investors. Importantly, almost three quarters of total public debt is in the combined hands of Eurozone governments, the EFSF and the ESM. Hence, Europe’s (conditional) commitment to keep Greek gross financing needs in check going forward suggests that rollover risks and interest payments on about at least 75 percent of total current public debt are likely to remain relatively limited in the future.

Figure 3: Greece’s government budget balance has improved remarkably
Figure 3: Greece’s government budget balance has improved remarkablySource: Macrobond
Figure 4: Greek debt is mostly in the hands of official institutions
Figure 4: Greek debt is mostly in the hands of official institutionsSource: IMF, Sov. Investor Base Dataset for Adv. Economies

Moreover, in the very short term, the liquidity risk is practically zero. The government’s cash buffer of around 24 billion euro (13.5 percent of GDP) should be sufficient to cover almost two years of financing needs after the end of the programme, based on current growth, revenue and expenditure predictions. Obviously, there is a risk that government revenue disappoints and/ or government expenditure overshoots, possibly due to an unexpected economic setback. In that case, financing needs would rise, possibly shortening the lifespan of the cash buffer. 

The cash buffer, Greece’s significantly improved (primary) budget balance, and the Eurogroup’s promise to do more if necessary should also limit market stress in the next few years[1]. That said, the risk that at some point the Greek are ultimately fed up with the tight fiscal policy restrictions alongside weak household finances, purchasing power and so on, remains present. Accordingly, the risk of new clashes with Europe somewhere further down the line cannot be neglected. If the risk that the Greek government is going to backtrack increases, market stress could still spur. And Greek government bonds will likely remain vulnerable to significant underperformance of the Greek economy and fiscal balances compared to the baseline in the institutions’ debt sustainability analysis for Greece. Finally, if uncertainty over the future of the Eurozone were to return, this would of course do not much good either. Yet based on recent market movements, it seems that a Eurozone breakup is currently not a top concern of investors.

In case of renewed market stress, it depends upon the ‘swift’ reaction of Europe and the Greek authorities how damaging the renewed market stress would be.

Will more debt relief be necessary?

The answer is that more debt relief will likely be necessary. Europe’s assumptions on Greece’s economic and fiscal outlook seem too positive, so more debt relief seems inevitable down the line. The European institutions expect economic growth to average 2 percent until 2022 and 1 percent thereafter until 2060 (figure 5), combined with a primary surplus of 3.5 percent until 2022 and 2.2 percent thereafter (figure 3). Such a scenario is unprecedented in history.

Figure 5: Greece has left the recession behind, opinions over longer-term fortune differ
Figure 5: Greece has left the recession behind, opinions over longer-term fortune differSource: Macrobond, EC, IMF, Rabobank, Nigem

To give an example. Europe’s surplus champion is Italy (that’s right, Italy). The country has been running a primary budget surplus for more than 25 years now (except in 2009 and 2010) of 2 percent on average. But this has come at a price. To reach this surplus Italy’s overall tax burden has become very high, while it is not compensated with efficient public spending and high quality public services. Average economic growth since 1992 has been 0.7 percent in Italy. And to be fair, there is not much reason to believe Greece will fare much better over the longer term. It is even more likely Greece will do worse, as you can read below.

The upshot is that government finances are expected to improve going forward and payment difficulties are expected to be limited in the short run, but Greece will continue to depend upon the mercy of Eurozone partners and the markets.

Has the economic environment improved?

Compared to the crisis years, the answer is yes. Compared to the pre-crisis years it is debatable.

The Greek economy looks set to grow

Figure 6: Unemployment has come down, but is still extremely high
Figure 6: Unemployment has come down, but is still extremely high Source: Macrobond, Rabobank

Between 2009 and 2013 economic growth averaged -5.9 percent per year. Between 2014 and 2016 average annual growth was close to zero. In 2017 the economy grew again, with 1.4 percent, on the back of a favourable external environment and investment growth (both private and public). Furthermore, unemployment has come down from its peak of 28 percent to 21 percent (figure 6), bank balance sheets have strengthened, and capital controls in place since mid-2015 have been loosened over the past years[2]. In the short term, we expect a further pick up of growth (about 2 percent in 2018 and 2019), as investments will likely get a boost from Greece’s clean exit from the programme, while tourism demand will remain strong. Consumption growth is likely to benefit from employment growth, but limited by further cuts to pensions in 2019.

The long-term potential remains rather weak

In the longer term, growth will likely slow again and in our view an annual growth rate of about 1.5 percent until 2030 and 1 percent thereafter, as projected by the European Commission, is still rather optimistic. For one because fiscal policy will have to remain restrictive for decades to come, if Greece wants to remain eligible for current and future debt relief agreements and to adhere to European budget rules. On the bright side, if this is enough to keep markets calm, prudent fiscal policy could support (foreign) investment. On the downside, restrictive fiscal policy to the length of days limits domestic demand, especially if it hurts consumption, which accounts for about two-thirds of total GDP. With household disposable income still almost 25 percent smaller than pre-crisis (it shrank in 7 out of the last 8 years, figure 7), further cuts to pensions in 2019 and to the tax free income threshold in 2020, that outlook does not look too bright.

Other factors informing our relatively pessimistic growth outlook are that Greece’s population is ageing rapidly, while productivity growth is very weak. Over the past two decades, labour productivity growth has stagnated and total factor productivity growth has even shrunk. What’s more, continued high (youth) unemployment of (43) 20 percent expectedly is still too high to stop the brain drain and feeds hysteresis – around one million educated young people are said to have left the country in recent years. And banks are still very weak with non-performing loans of over 40 percent, limiting their ability to stimulate economic growth and withstand another crisis.

Figure 7: The economy and households’ wallets still significantly smaller than pre-crisis
Figure 7: The economy and households’ wallets still significantly smaller than pre-crisisSource: Macrobond, Rabobank calculations
Figure 8: Doing business in Greece is difficult
Figure 8: Doing business in Greece is difficultNote: The highest rank is 1. In 2009 Greece ranked 97th, i.e. worse than today.
Source: Macrobond, World Bank

Meanwhile, the fundamentals of the Greek economy remain weak, despite all the reforms that have been adopted, which hurts the country’s investment outlook and growth potential. Admittedly, the ease of doing business has improved in the past years. But doing business remains tough. Within the EU, it is only more difficult in Malta (figure 8). Furthermore, international competitiveness (figure 9) and governance in Greece is now weaker than prior to the crisis (figure 10). Greece ranks last among EU countries in the Global Competitiveness Index.

Figure 9: International competitiveness is weak
Figure 9: International competitiveness is weakNote: The highest rank is 1. In 2008 Greece ranked 67th, i.e. better than today. Source: Macrobond, World Bank
Figure 10: Governance indicators do not bode well for long-term economic outlook
Figure 10: Governance indicators do not bode well for long-term economic outlookNote: The highest score is 100. Source: Macrobond, World Bank, Rabobank calculations

Of course we could be surprised positively. It generally takes a while before reforms generate gains and as such the payoff of all the reforms implemented in the past years could be higher than currently seems the case. And potential growth could accelerate if Greece indeed continues to reform and strengthen its economy, as stated, with technical assistance provided by the EU. But for sure there is still a very long way to go to bring wealth back to pre-crisis levels and to seriously lift the country’s growth potential to outgrow the massive debt burden.

Footnotes

[1] The ESM will have to approve before Greece can use of its cash buffer. As such, the cash buffer will indeed only be used in case of heightened market stress, and not for current expenditures. But it is not entirely clear yet how the interaction between Greece and the ESM runs. If the requirement of Europe’s signature delays the possible use of the cash or comes with conditionality it could limit the cash buffer’s potential to stem market stress.

[2] The limit on cash withdrawals has been raised from 60 to 5000 euro per day. The limit on international transfers by individuals has increased from 0 to 4000 euro every two months. For businesses the limit on cash transfers abroad has been increased from 0/ a case-by-case approval requirement to 40000 euro per client per day.

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