Why Greece Still Needs Debt Relief

FORTUNE

COMMENTARY by  Barry Eichengreen  @b_eichengreen  MAY 11, 2016, 3:29 PM EDT

The Greek debt crisis is the crisis that never stops giving. More than six years have now passed since the crisis broke, and the country is still struggling to get its finances under control. In the latest installment, Greek lawmakers agreed early Monday morning to a new set of pension and tax reforms.

Unfortunately, the new package will not be enough, by itself, to prevent the crisis from blowing up again. Its higher marginal tax rates for top earners, lower tax-free thresholds, and additional pension cuts are designed to reduce the budget deficit by 1.5% to 3% of GDP. This is an expression of good faith intended to reassure German finance minister Wolfgang Schauble and his constituents.



But it pushes Greece to the breaking point, as we are reminded by the percussive sound of petrol bombs exploding in Syntagma Square. Pensions for the poor and basic social services have been cut to the bone. And, in and of itself, the new package will once again fail to put the government’s debt—in excess of 180% of GDP—on a sustainable path. For this, meaningful debt reduction will be required.

Whether other European countries—specifically Germany—are prepared to meet Greece halfway is still in question. The EU has offered concessions on the interest rate on Greek government bonds held by the European Central Bank and other institutions of the European Union. But even then, Greece will have to run primary budget surpluses (ignoring interest payments) of 3.5% of GDP from now to eternity in order for the sums to add up. Persistent surpluses of this magnitude are something that only a small handful of countries in recorded history have been able to sustain. The countries in question have generally had strong governments and institutions. Does this sound like Greece to you?

To square the circle, Greece will need additional debt relief. The cosmetic way of achieving this—without writing down the face value of the debt—is through additional interest rate reductions and maturity extensions. In effect, Greece’s debt would be turned into infinitely lived zero-coupon bonds, on which no interest is paid and principal repayments are deferred to some future century. These half-measures are designed to avoid riling German taxpayers. But whether Germany is willing to swallow even these concessions is unclear. Although Schauble has indicated that he might be prepared to contemplate some form of further debt relief for Greece later this month, this is far short of a commitment.

And even then, the arithmetic may not work, given how Greece’s recession continues to cut into the government’s revenues. There are only two solutions. One is fundamental rather than cosmetic debt relief: writing down the value of the country’s debt once and for all through a proper restructuring. Cutting the principal—and thereby eliminating the debt overhang (some of which Greece will have to refund at market interest rates as early as 2018)—would reduce uncertainty and encourage the investment that Greece so desperately needs. It would help get the economy growing again.

The other option is still higher taxes. As a contingency plan, Greek finance minister Euclid Tsakalotos has proposed additional increases in marginal tax rates, along with spending and pension cuts. The International Monetary Fund is insisting instead on widening the tax base—eliminating the exemptions that permit too many Greeks to escape paying taxes. It proposes protecting pensions and social services for the poorest by instead achieving the same economies through administrative and regulatory reforms that have so far been resisted by special interests.

It is one of the ironies of the crisis that the Greek government of Alexis Tsipras has been painting the IMF as the villain in this plot. It is true that the Fund supported the latest round of tax increases and is insisting that Greece push forward with deep structural reforms. But the IMF is skeptical of the feasibility of further increases in marginal rates, and is an advocate of the idea that Greece needs fundamental debt relief, which is of course what the Greek government wants as well.

This finger-pointing is a convenient way for Tsipras to shield his government from criticism over budget cuts. Cuts in public services are not popular, to put an understated gloss on the point. But because they were proposed by his own finance minister and supported by his party, he’s conveniently blaming the IMF. And so Tsipras’ minority government lives to fight another day.

But now, as the issue of debt relief comes to the fore, Tsipras must pivot from demonizing the IMF to praising it. This political course correction won’t be easy. But then consistency has never been a prerequisite for success in Greek politics.

Barry Eichengreen is George C. Pardee and Helen N. Pardee professor of Economics and Political Science at the University of California, Berkeley.