Dismal Debt Outlook for Greece Raises Pressure on European Creditors

Forecast comes amid surprise data showing Greek economy grew instead of shrinking in second quarter

The Wall Street Journal

By MARCUS WALKER And  STELIOS BOURAS

Aug. 13, 2015 2:48 p.m. ET

ATHENS—A bleak debt forecast for Greece is raising pressure on Europe to grant the country softer loan terms, exacerbating tensions among its creditors as they try to seal a new Greek rescue deal within days.

The new forecast, prepared by European Union officials in a document seen by The Wall Street Journal, predicts sharply higher Greek debt than Europe had previously hoped and shows just how far Greece is from escaping its marathon crisis.

The assessment, which calls for “debt-mitigating measures,” increases the likelihood that its creditors, led by Germany, will have to allow Athens significantly more time to repay its huge bailout debt, European policy makers say. That conclusion is politically painful for Berlin but now looks mathematically inescapable, these officials say.

The worsening outlook stood in contrast to some rare good news from Athens: Government data showed the Greek economy grew in the second quarter, defying expectations of a deepening slump—at least up to June.

But the economy is widely thought to have worsened since late June, when Greek authorities imposed capital controls at the height of this summer’s confrontation with their foreign creditors. In their prognosis for Greece’s debt, the European institutions blamed the standoff for knocking the country’s economic outlook and budget off course.

Finance ministers from the 19 countries that make up the euro currency zone are due to debate Greece’s mountainous debt and its new bailout program in Brussels on Friday afternoon. Greece’s parliament is expected to approve the bailout plan, including tough new austerity policies, earlier in the day despite a likely rebellion by some lawmakers in the ruling Syriza party. Greece needs billions in financing from Europe to repay bonds that mature on Aug. 20.

The new three-year bailout plan—including up to €86 billion in loans, Greece’s third financial rescue package since 2010—is likely to secure all sides’ approval eventually. But the debt crisis that has roiled Europe for five years looks far from over. Greece’s fraying government is signaling it will call snap elections this fall, with unpredictable consequences for its adherence to its bailout deal. The deal’s precarious math, as underscored by Thursday’s leaked EU analysis of Greek debt, show Europe is still a long way from restoring Greece’s solvency.

If this year’s diplomatic drama between Athens and Europe has highlighted Greece’s political unpredictability, Thursday’s data showed its economy can surprise too. Gross domestic product was 0.8% higher in the second quarter than in the first three months of 2015, Greece’s official statistics agency Elstat said. First-quarter GDP was flat compared with the last quarter of 2014, Elstat said, revising an earlier estimate that output fell in the quarter.

The positive GDP data surprised analysts and policy makers and suggest that Greece’s economy weathered the political uncertainty over the country’s bailout program and its place in the euro better than most people feared. Economists had expected the data to show a marked contraction in the second quarter. Although no breakdown of the GDP data is available yet, analysts said a strong start to the summer tourism season—and possibly resilient consumer spending—are the most likely explanations for the surprise.

“The surprise is partly explained by some consumption indices, such as retail sales, that were in positive territory in the second quarter and this was helped by some improvement in the labor market,” said Nikos Magginas, economist at National Bank of Greece, the country’s biggest bank. “There was also a very strong positive impact from tourism, which is having increasing knock-on effects on the economy.”

But economists cautioned that the good news was very unlikely to last. The GDP data only go up to June, just before Athens imposed capital controls and closed the country’s banks for several weeks. Greek businesspeople say the continuing restrictions on financial transactions have sharply reduced economic activity, and that the effects will likely be felt for many months.

“The capital controls were a catastrophe for the economy,” said Kallinikos Kallinikos, CEO of Goldair Group, a provider of transport, tourism and airport ground-handling services. “The damaged caused by the shutting down of banks will appear in the second half of 2015,” and the effects could still be felt in 2016, he said.

Capital controls have since been relaxed slightly but are continuing to weigh on the economy. No one knows quite how long Greek authorities will have to keep the restrictions on financial transactions in place. In Cyprus, it took two years to fully remove capital controls after their imposition in 2013.

Many consumers, households and businesses put off making payments in July, ranging from paying taxes to shopping for groceries, as people tried to preserve cash in the fact of tight limits on ATM withdrawal limits. That also contributed to government revenues falling 40% short of their target in July, budget data released on Thursday showed.

Consumer spending on large items also plummeted last month, with new car sales falling 23.9% to 8,181 in July, the steepest drop in more than two years, according to earlier figures from Elstat. Greece’s manufacturing sector also took a massive hit in July, with the Purchasing Managers Index plummeting to 30.2, the lowest level recorded in the 16-year history of the series.

The EU institutions monitoring Greece’s bailout, led by the Brussels-based European Commission, blame the capital controls and this year’s political tensions for wrecking a debt outlook that, they argue, was starting to look good by late 2014.

The EU analysis, prepared for Friday’s eurozone finance ministers’ meeting, says Greek government debt will peak at 201% of gross domestic product in 2016, and will fall only slowly to 160% in 2022, even assuming Greece carries out its tough bailout regimen in full. Incomplete implementation of the bailout terms, including disappointing proceeds from privatizations and foot-dragging on economic overhauls—the usual experience since Greece’s rescue began in 2010—would leave the debt ratio even higher, the document says.

Governments of the 19 countries in the eurozone had previously promised to bring Greece’s debt to below 110% of GDP by 2022, in an effort to convince the International Monetary Fund that Greece’s debt is sustainable and keep the IMF involved in Greece’s financial repair.

The EU analysis suggests Greece’s debt is so far off track that major debt relief is unavoidable. The document calls for long postponements of the dates by which Greece must repay its bailout loans or pay any interest on them, arguing that outright loan forgiveness—politically unacceptable to Germany and other creditor countries—isn’t necessary.

The IMF has warned Europe repeatedly this summer that very long extensions to Greece’s loan maturities are the only alternative to outright loan forgiveness. Germany, however, is reluctant to extend Greece’s repayment dates too much. Berlin officials argue that excessively long extensions of loans whose average maturity is already 30 years would be a disguised way of saying much of the taxpayer money lent to Greece is lost.

Difficult negotiations between the IMF and eurozone governments, led by Berlin, are expected before the IMF decides whether to continue taking part in the troubled Greek bailout.

—Gabriele Steinhauser in Brussels contributed to this article.