Game of loans

Considering where it was two years ago, Greece’s financial situation does not look too bad. Having come within a whisker of falling out of the eurozone, its future membership now looks relatively secure. It has returned to modest growth, dramatically reduced its primary deficit and done more than any other European country to reduce costs in terms of wages, pensions and healthcare.

Yet, considering how far behind it was, this has not been enough. Besides the long list of reforms its creditors say it needs to implement, the banking sector is hobbled by a high rate of non-performing loans, while unemployment and underemployment remain serious problems. In addition, if cooperation between the EU and Turkey were to break down, the flow of migrants from Turkey to the shores of Greek islands could resume, with devastating economic and political consequences.

With much of the impetus for reform coming from outside Greece, and having been grudgingly accepted by Greeks and the national government, it has been hard to maintain the early momentum. The more Prime Minster Alexis Tsipras complies with Greece’s creditors, the more his poll ratings fall, making it increasingly difficult for Syriza to go along with their demands.

Greece’s inability to push through better and faster reforms cannot be blamed entirely on Syriza or the unpopularity of the required changes, said Nicolas Veron, senior fellow at Bruegel, a think tank.

“It is about Greece’s political structures and economy, including the role of influential families. It is very sad to say, but it has made most progress in areas where decisions have been taken outside of Greece, for example in banking, where the supervisor in Frankfurt has more responsibility,” he said.

This is putting the Greek government under considerable pressure. A JP Morgan research paper argued the risk of an early election in Greece is rising as the political costs of complying with creditor demands increases.

“We believe that a new centre-right government, which looks overwhelmingly likely on the basis of the current polls – New Democracy leads by 10%–15% – would be more effective in forging a productive relationship with the creditors,” said JP Morgan.

Creditors disunited

Yet it is the uncertainty deriving from the growing divergence between the IMF and the EU, the architects of Greece’s rescue package, that poses the biggest immediate risk to Greece’s future. Disagreements between the creditors over what conditions to impose on Greece, and between the Greek government and both of its creditors, have created another in a long line of impasses, the route out of which is far from clear.

At the heart of the problem is the sustainability of the Medium Term Fiscal Strategy, or what primary surplus targets creditors should impose for the period after the current bailout programme expires in 2018. The IMF says Europe must grant significant ex ante debt relief if it is to continue its participation in the programme, arguing the high primary surplus targets, on which the EU insists, are unrealistic and will undermine growth. It has identified a 2% fiscal gap and requires clarity over how the Greek government will achieve the 3.5% agreed primary surplus target, demanding legislation to ensure adequate measures are implemented for the period from 2019 onwards.

Europe is unwilling to grant ex ante debt relief, insisting the target of a 3.5% primary surplus over an extended period is feasible.

It will be politically challenging for the three sides to resolve their differences before the German elections in September. Yet this is what must happen if Greece is to make the repayments of €6.4bn that are due in July.

These disagreements may reflect the increasing sophistication of the EU. Veron said: “In the early days the IMF was clearly more competent than the EU and ECB, having had experience of sovereign debt crises. But the Europeans have closed that competence gap. The differences between them now are driven by political constraints on both sides.”

It also illustrates the evolving political pressure on the IMF, said Veron. “The IMF is taking a strong stance on sustainability, in contrast with its position in 2010, which many said was too soft in this area. But this has not made it a natural ally of the Greek government, because it wants the numbers to add up in things like pension reform. That does not seem to be a priority for the Greek government.”

Yvan Mamalet, senior euro economist at Societe Generale Corporate & Investment Banking, said: “The IMF has accepted the EU will never accept haircuts on ESM or EFSF debt, and is now talking about extending maturities. That would allow Greece to meet its gross spending needs and to stay away from the markets until around 2040. By then, it should have got its debt-to-GDP ratio down to around 100%, which would make capital markets issuance possible. That does look more achievable for Greece as things currently stand, although it will be very difficult for Greece to stay within its financial constraints for such a long time.”

Other big disagreements revolve around labour labour law reforms, pensions and tax, with other issues such as reforming the energy sector also causing some friction. On the labour market, the IMF is calling for a more a liberal approach that departs from EU norms in matters such as collective bargaining and collective dismissals.

Pension reform is also a huge challenge: Greece has a population of around 11 million, of which around 3.1 million are pensioners. According to Dimitris Paraskevas, managing partner at Elias Paraskevas Attorneys in Athens, it now takes 10 salaries to pay each person’s pension.

On tax, views range from those who say the tax burden is so crippling that it has become almost impossible for working Greeks to earn a living, to those who note that the state still does not come close to collecting what it is owed.

The IMF claims that 50% of Greek Tax-payers fall below the tax-free threshold of €8,600, arguing this limit should therefore be increased. That would present significant political challenges for the government, which puts its own estimate for this figure at 12% and says no further reforms are needed.

“The tax situation is very difficult in Greece and it is hard to see how companies can pay it and survive,” said Paraskevas. “The bill – including prepayment of tax, tax on dividends, social cohesion tax, professional duty, real estate tax, non-deductible expenses and social security contributions – can be 85%. In some instances, and if you factor in social security contributions and those whose wealth comes from real estate rather than income, it can be 100% and more. This means many businesses prefer to move their domicile to lower cost jurisdictions, like Bulgaria and Cyprus, or move out of Greece altogether.”

Masters of brinkmanship

Most are still hopeful a compromise will be reached that keeps the IMF financially invested in the process. While officially there has been no agreement between the EU and the IMF, some political back-channelling between the latter’s managing director, Christine Lagarde, and Germany’s chancellor, Angela Merkel, seems to have achieved a temporary understanding. It is hoped the IMF will agree to proceed as a technical advisor with some acknowledgement of the need for reforms, even if implementation is gradual.

But with Europe’s political landscape in a state of flux, it remains unclear how much attention will be devoted to Greece or how long its appetite for Greek bailouts and holding the EU project together can be maintained. The UK’s decision to leave the EU may have changed the nature of the Grexit debate: Greece’s eurozone status would make its divorce messier than the UK’s, but where in 2015 there was a desire to hold the EU together and not set a precedent for members leaving the bloc, that precedent has now been set.

Neither can the Greek commitment to the process be taken for granted. “If the alternative to large relief measures is to stick with the austerity programme for 20 years, fears of Greece leaving the euro may re-emerge,” said Mamalet.

Louis Gargour, managing partner at LNG Capital, a hedge fund investing in European credit, dismissed this possibility.

“There is no appetite internally to investigate the drachma scenario,” he said. “This government does not have the mandate from the Greek people to do so. It could have done it back in July 2015 but they did not have the courage. Now it is too late, after having implemented such austerity.”

The arithmetic of the trade balance does not add up for Grexit, said Gargour, as Greece would “very quickly run out of basic goods such as medicine and oil and chaos would ensue. Also, with Turkey being in such a volatile state, it would be suicidal to leave the European umbrella”.

Greece will therefore have to accept all IMF’s requirements, he said, possibly with some fiscal policy fine-tuning in the form of tax breaks, and the promise of further QE, to help smooth implementation.

All this paints a depressing future for the people of Greece.

“The outlook is good for some and bad for others,” said Paraskevas. “Pensioners will be among the worst hit and will suffer to an unbelievable extent, with living standards comparable to old people in developing and third world countries. The average men and women on the street, with poor levels of training and low salaries, will also be much poorer than they are today. But some companies will benefit, such as those with connections to infrastructure, food supply or tourism.”