Greece Has the Resources to Heal Itself

But it will have to curb tax evasion or remain an eternal ward of the euro zone.
By Leonid Bershidsky

Bloomberg

23 May 2017

The euro area's finance ministers again failed to come to an agreement on debt relief for Greece. No surprise there. Hammering out the details would force them to accept an uncomfortable reality: Greece won't be ready to tap private debt markets for years to come. In the meantime, if it wants to get off life support, it will have to find a way to cut tax evasion.



The unpopular Greek government of Alexis Tsipras keeps trying for a debt-relief deal. All its many concessions, which have made Greeks and everyone else forget this was once a rebellious, far-left cabinet, are geared toward that goal, and so is the mammoth, 245-page austerity bill passed last week. There are more pension cuts and more tax increases, all in the name of showing shareholders that Greece is willing to be frugal and so should be allowed to tap markets again. Starved of investment, the country is in recession again, the only euro-area member to report negative growth (minus 0.5 percent year-on-year) in the first quarter of 2017. Greece almost certainly won't meet the growth target set by the European creditors -- 3 percent in 2018; the Bloomberg consensus forecast for that year is just 1.9 percent.

A nominal haircut for official investors is, however, a red line Germany and other northern European countries won't cross, as the Eurogroup reiterated in its statement on Monday. Instead, the statement repeats the insistence that Greece maintain a primary budget surplus of 3.5 percent of gross domestic product for the medium term. The International Monetary Fund wants more specifics from Greece's creditors on how maturities and interest rates on the debt will change if it is to keep taking part in the Greek program. The Greek government wants a deal so it can explain to voters why they're expected to put up with continued austerity. The required specifics, however, can only emerge before the September election in Germany -- say, at the next Eurogroup meeting in June -- if the creditors incur no additional costs. Otherwise, Chancellor Angela Merkel's government will have to answer to conservative voters for her inability to stop paying Greece.

The only practical reason to rush to a deal is to speed up Greece's access to private debt markets -- something the creditors would be wise to delay, as Jeromin Zettelmeyer, Eike Kreplin and Ugo Panizza wrote in a recent working paper for the Peterson Institute of International Economics.

With the current interest rates and repayment schedule, Zettelmeyer and his collaborators wrote, Greek debt would remain sustainable through at least 2028 under the most pessimistic scenarios -- that is, even if the Greek government proves, like every other high-debt country in history, unable to maintain a 3.5 percent primary surplus for more than a few years. From there on in, its gross financing needs -- the amount it would need to borrow -- would exceed 20 percent of GDP, the generally accepted sustainability ceiling. That can only be averted if, after putting off debt maturities and cutting interest rates as much as possible, the creditors can continue funding Greece, and continue to bar access to more expensive private markets.

The longest ESM bond in circulation today, maturing in 2055, yields 1.78 percent. There's no way Greece will be able to fund itself at such low rates in the foreseeable future. The 2026 bond issued by Portugal, which has successfully exited its bailout program, yields almost 5 percent.

At the same time, ESM funding doesn't really cost Germany and other euro members anything; they've pledged 80 billion euros ($90 billion) to the stability mechanism so it can get these rates, but they're not actually paying out the money -- their reputations serve as security.

Despite that, there's a political cost to extending the funding: Voters often don't understand how the mechanism works, believing that funding to Greece comes out of their pockets. Greeks too are weary of the strings attached to the ESM loans; they'd love more freedom to run their own country. Giving them that opportunity, however, may mean kicking the can down the road. If Greece comes back in a few years' time with a worse problem than today, a new bailout will be far costlier.

After all these years, Greece still has a large resource it could use to fix the problem. The Athens think tank diaNEOsis found last year that the country loses between 6 percent and 9 percent of economic output in unpaid taxes -- at least 11 billion euros. The government's efforts to collect that money are often bizarre. Greeks, for example, are offered tax allowances if they spend a certain share of their income in non-cash form -- for example, 20 percent of an income that exceeds 30,000 euros a year -- and threatened with fines if they spend less. The government recently unveiled a piece of software that's supposed to check tax declarations against bank deposits dating back to 2002. Both measures create a bureaucratic mess for taxpayers, who need to keep or retrieve lots of records and receipts, but they hardly stop people from hoarding cash outside the banking system. Greece has far more self-employed workers than the European average, and, according to diaNEOsis, they hide up to 60 percent of their income.

Tapping this money would completely change Greece's debt repayment math; it would make a 3.5 percent surplus sustainable or speed up growth. Greece, of course, doesn't have much leeway on lowering taxes to stimulate collection, as the Tsipras government has repeatedly found in negotiations with creditors. "Revenues must increase so that the tax rates are reduced," Finance Minister Euclid Tsakalotos said recently. That's hard to do; in countries that have managed to raise tax collection, this order of actions was reversed.

Ultimately the government needs to give Greeks a reason to pay taxes, and that will require both the carrot of better, more efficient services and the stick of stiff penalties for those caught for dodging. Tsipras and his team need to make the argument that tax-cheating prolongs the suffering of many Greeks and that paying taxes isn't just a legal obligation, but an act of patriotism that will help the recovery. That's a hard sell, but also Greece's best bet at tapping some of those hidden reserves.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net