Athens's Love Affair With the Euro Persists

The Wall Street Journal

Nov 3 2013

“…The current crisis may be Greece's last opportunity to turn itself into an effective modern state…”

Even After Six Years of Recession, the Greek Government and 69% of the Public Support the Euro

Across Europe, there is now a broad consensus that the decision to allow Greece to join the euro was a mistake. Yet ironically, the one place where this view is not widely shared is Greece itself.

Even after six years of recession, a 26% slump in output and unemployment of 27%, the Greek government considers membership of the single currency an article of faith, while 69% of the public supports the euro, according to a recent poll by the Pew Research Center.

Perhaps this isn't so surprising. The crisis did not come out of a clear blue sky. Greece missed multiple opportunities over many decades to fix a broken political and economic model marked by cronyism, corruption, bureaucracy and excessive borrowing: following the overthrow of the military dictatorship in the 1970s, when Greece joined the European Union in the 1980s and in the run-up to joining the euro in the early 2000s.

The current crisis may be Greece's last opportunity to turn itself into an effective modern state.

Greece's ability and willingness to make this transition will be put to the test again on Monday when its official lenders return to Athens for the much-delayed latest review of progress with its bailout program. The government is running out of time to reach a new deal with the so-called troika—comprising the International Monetary Fund, the European Commission and the European Central Bank—to cover a projected shortfall of between €500 million ($674 million) and €2 billion ($2.69 billion) in next year's budget. At the same time, it must also agree to further cutbacks for the following two years that will play a role in determining how the euro zone plans to cover Greece's estimated €10 billion funding gap in 2015 and 2016.

Athens believes it has a strong case to be cut some slack. For the first time since the start of the crisis, Greek economic forecasts are being revised upward; the economy is now widely expected to shrink by less than 4% this year compared with an IMF forecast in June of 4.2%, and some forecasters now predict a return to growth in 2014.

The government is now confident it will deliver a small primary budget surplus before interest payments this year, a remarkable turnaround from a 15% deficit in 2008. The current-account deficit, which was 11% in 2008, has largely been eliminated. At the same time, unemployment appears to have stabilized and labor costs per hour are now 30% below 2008 levels, restoring much of the competitiveness lost over the previous decade, notes Alpha Bank.

Market sentiment is also improving. Last week, Greek 10-year government bond yields fell below 8% for the first time since 2009. Now is not the time, says Athens, for the troika to imperil this tentative stabilization with new fiscal demands. Or as President Karolos Papoulias put it rather more bluntly in an emotive speech last week, Greece will not give in to "blackmail."

Similarly, senior government officials argue that the troika needs to recognize the challenges Athens faces in trying to deliver reform while maintaining faith in free markets and democracy.

Following a political crisis earlier this year that resulted in the departure of a minor coalition partner, the government has a wafer-thin majority. Prime Minister Antonis Samaras's New Democracy party is running neck and neck in the polls with Syriza, a coalition of radical left-wing parties. The far-left and far-right currently poll up to 12% of votes. The murder on Friday of two members of the far-right Golden Dawn party shows the situation remains volatile.

Mr. Samaras hopes that a combination of a recovering economy plus success in next year's local and European Parliament elections will strengthen his position, creating political space for wider reform, according to someone familiar with his thinking. But for this to happen, Mr. Samaras needs the troika to give him the benefit of the doubt.

The troika can be forgiven for being skeptical. Memories of Mr. Samaras's two-year populist campaign against the bailout conditions are hard to dispel. Besides, much of the recent improvement in the economic data reflects a record tourist season. And even this cannot obscure Greece's lack of progress in implementing many of its reform commitments.

The latest tax receipts may be in line with budget forecasts, but tax evasion remains endemic. Privatization receipts are far below target. Public-sector reforms are proceeding at a glacial pace. An ineffective justice system remains a major barrier to investment.

A commitment to sack 15,000 civil servants over the next two years, with 4,000 to be laid off by the end of 2013, has been a perennial feature of troika reviews and still hasn't been completed.

A separate plan to place another 25,000 into a special mobility scheme is also facing difficulties.

Thanks to a crude one-in-for-every-five-out rule, the civil service has been cut to 23% of the total workforce, closer to the EU average. But it is still much too large, resources are poorly distributed across the public administration and there are serious quality deficiencies in some areas, acknowledge senior government officials.

Meanwhile, government actions may actually be hampering the prospects for recovery. A rough-and-ready property tax helped plug the fiscal hole but slashed household spending power and killed the housing market. At the same time, a populist ban on banks' foreclosing on unpaid mortgages may have worsened banks' bad-debt problems—Alpha Bank estimates up to 30% of its non-performing loans are "strategic"—while making them even more reluctant to extend new loans.

The government insists the banking system is adequately capitalized. But until a transparent clearing price is established for real estate, banks are unlikely to attract new funding to reduce their reliance on ECB facilities and so will remain under pressure to deleverage; that suggests the vicious credit crunch will continue, hampering the recovery.

No doubt the troika must make difficult judgments, balancing political pressure on all sides to declare the Greek program a success against the need to recoup existing loans.

But whatever deal Athens secures on future funding and fiscal measures, it seems unlikely that the troika will let up the pressure for far-reaching reform: after all, to do so would be a betrayal of all those Greeks who continue to put their faith in the euro.

Write to Simon Nixon at simon.nixon@wsj.com