A Flawed Plan B for Greece

Little common ground exists for Greece and the eurozone to commit to reach a new long-term deal

The Wall Street Journal

By SIMON NIXON

Feb. 15, 2015 6:51 p.m. ET

It is a mark of the gulf that still separates Greece and the rest of the eurozone that an agreement last week simply to engage in “technical discussions” was hailed as a step forward in the search for a solution to the country’s debt crisis.

It was certainly a climb-down by the new Greek government, which had previously ruled out any negotiations with its “troika” of international lenders. And it followed previous climb-downs: Athens is now asking for debt restructuring rather than write-downs, and it now says it will abide by 70% of the reforms required under its current bailout program.

But talking signifies nothing. Even this latest step was only possible on the basis of a fudge after an initial attempt by eurozone finance ministers to start talks fell apart. The eurozone insists the purpose of the discussions is to assess the Greek government’s plans with a view to extending the existing bailout plan, thereby securing Athens the financial breathing space to negotiate a new long-term deal. Athens says the purpose of the discussions is to prepare the way for an entirely new program, an extension of the old one being out of the question.

Few believe that finance ministers will resolve this impasse at a special summit on Monday—or even by the end of the week, the point at which it becomes too late to secure the necessary parliamentary ratification in several member states for a program extension.

Any hope of a deal hinges on what Athens means by “70% of the program” and whether Prime Minister Alexis Tsipras can wring sufficient fiscal and reform concessions to enable him to sell an extension as a “new” program. The crucial sticking point is Greece’s insistence on reversing key labor-market reforms. “That is nonnegotiable,” says a senior German official. “We consider these to be 80% of the program.”

Faced with the risk that Greece does allow its current program to lapse when it expires at the end of this month, some eurozone officials have started to discuss how to make a program exit as “clean” as possible. This would involve setting out a clear timetable for negotiations on a new program, including a deadline for a deal, says one of these officials. The hope is that this would encourage Greeks to keep their money in the banks and persuade the European Central Bank to continue to allow the banks to receive emergency funding. That might buy a little extra time to negotiate a new long-term deal.

As a Plan B, this is deeply flawed. The Greek economy contracted by 0.2% in the fourth quarter of 2014, on a quarterly basis, confounding expectations of 0.4% growth; tax receipts came in more than 20% below target in January and an estimated €14 billion ($15.95 billion) of deposits have been withdrawn from banks since the end of last year, forcing the ECB last week to increase the ceiling for emergency liquidity assistance to €60 billion. No one knows for sure when Athens will run out of money, but there are fears it could be as soon as March. Yet officials say that negotiating a new deal would take a minimum two to three months.

Besides, it isn’t clear that there is sufficient common ground for Greece and the eurozone to credibly commit to reach a new long-term deal on the basis of their current positions. Athens is now firmly shut out of the markets, with three-year borrowing costs around 20%. Any new program will therefore have to fund Greece for at least the next two years, during which it must roll over €24 billion of financing. And this new bailout will inevitably come with conditions that will in turn require monitoring by the lenders. Is Mr. Tsipras, who took office promising an end to bailouts and troika oversight, ready to swallow such a bitter political pill?

Crucially, any new program will almost certainly involve the IMF. This is a red-line issue for Germany and other member states. The IMF is needed partly because eurozone governments only recently helped boost the fund’s coffers and will want to use this cheap funding to reduce the burden on themselves. More importantly, the IMF has a fiduciary duty to its shareholders to ensure that any new borrowing is sustainable. Its involvement is therefore an important source of reassurance to eurozone parliaments that taxpayers should get their money back.

Yet the involvement of the IMF is likely to complicate the search for a new deal, particularly if the eurozone sticks to its condition of no debt write-downs and Athens continues to insist on implementing its economic program. There are two problems.

The first is the issue of Greece’s fiscal targets and their impact on Greece’s debt trajectory. Even assuming loose fiscal policy delivers a substantial stimulus, a cut in the primary budget surplus target to the 1.5% that Athens is demanding, from the 4.5% required under the current program, could require Greece to borrow an extra €42 billion by 2020, according to Zsolt Darvas of the think tank Bruegel. Some of the impact could be offset by a generous new bailout package that extends the maturities on existing loans by 10 years and cuts the interest rate to match the eurozone’s funding cost. But this won’t stop Greece’s ratio of debt to gross domestic product from rising higher by 2030 than envisaged under the old program.

The second issue is the growth assumptions underpinning any analysis of Greece’s future debt sustainability. The IMF is likely to be skeptical of Athens’s faith in a consumption-driven recovery built around raising the minimum wage, rehiring many of the sacked civil servants, restoring collective wage bargaining, cutting taxes and boosting welfare payments. The IMF has spent five years insisting on measures designed to encourage investment-led growth, including product- and labor-market reforms, overhauls of the tax and insolvency codes, and privatizations, much of which Mr. Tsipras at the time opposed. Indeed, the IMF’s determination to stick to its guns contributed to the fall of the previous government. It is unlikely to change its views now.

If Mr. Tsipras feels unable to make the climb-downs necessary to secure a short-term program extension, he may find the concessions needed for a long-term deal harder still.

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