Greece: The Road to Ruin?
An Oxford Analytica Open Conference Call, November 4, 2011
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Oxford Analytica experts including Professor George Pagoulatos, Professor Erik Jones and Dr Jens Bastian discuss the crisis in Greece and the potential contagion effects across the EU.
Call summary
Will Greece live up to the requirements of the EU bailout plan?
Three days after agreeing to the revised EU bailout plan at the October 26-27 summit, Greek Prime Minister George Papandreou’s unexpected call for a referendum in order to build popular support for reforms caused great turmoil among European leaders and markets. The proposal has been discarded; the Papandreou administration’s resignation, replacement by an interim government and date for early elections will follow.
What kind of government might emerge?
Opposition New Democracy (ND) is leading in the polls and would probably lead the next elected government.
However, in the meantime, it is under pressure to join a government of national unity with the ruling Socialists (Pasok). That would have the mandate to meet the terms of Greece’s bailout undertakings to the ‘troika’ of the EU, ECB and IMF, and pass necessary legislation, including the 2012 budget. This is necessary to secure the next tranches of bailout funds and stave off imminent default.
Can public opinion bear the weight of more austerity measures?
The domestic situation is problematic and public opinion is demoralised by the uncertainty over when the suffering will end. Recovery will clearly take several years, with Greece entering its fourth year of recession.
The endurance of the Greek public is being tested but a general consensus seems to be emerging that radical reform is required, both among the masses and the political class.
Is Greek public opinion adamantly in favour of keeping the euro?
Greeks are realising that if they do not comply with the troika’s terms, the alternative is expulsion from the common currency with all the dramatic consequences this will have for the economy and society as a whole. Given the choice, most people would accept terms that go with euro membership. There is cross-party consensus, except for some leftists, that the only road to recovery is that set by the troika.
Will Greece seek to renegotiate the agreement?
The prime minister’s recent initiative to put the austerity policy to a referendum has eroded EU confidence in Greece’s commitment to reform. The ND party of Antonis Samaras may try to vary the details, but any changes will only be cosmetic, as the fundamentals of the deal for fiscal consolidation are non-negotiable.
Could the Greek government decide unilaterally to leave the euro and default on interest payments?
This is unlikely, at least for the next two or three years, although left-wing factions continue to campaign for euro exit. Put simply, returning to the drachma would have devastating consequences. Greece is often told to follow Argentina’s example and devalue to boost exports, but that would only have limited effects as the country relies heavily on imports. Therefore, there is near-consensus that the euro is ‘sacrosanct’ and ND has voiced its support in principle of the current bailout.
Has the aborted referendum impaired Greece’s credibility?
A ‘red line’ was crossed when Papandreou made the political blunder of calling for a referendum on a plan that had already been agreed. It is extremely important that the referendum has now been scrapped -- in these delicate times, the consequences would have been catastrophic whatever the outcome of the vote. Nonetheless, Papandreou has damaged Greece and its standing in the EU.
The IMF and euro-area had made it clear that some options were not available to Greece. Greek Finance Minister Evangelos Venizelos, a leading figure in Pasok, argued that going down that road would cost Greece its next bailout tranche.
What would happen in the event of Greece defaulting on its payments?
The consequences would be immense; leaving the euro might very well mean also leaving the EU. The stakes are simply too high. It took decades of effort to join the EU and the euro – Greeks would not want the country’s most successful policy of recent years to come to naught.
Moreover, further afield, a disorderly Greek default would carry high risks for Italy and Spain, if not an outright downward spiral.
Can Italy be protected from contagion?
Italy can and must protect itself. The IMF is joining the European Commission in seeing to it that Italy lives up to its financial reform commitments, but the reality is that it can do so only if the government is strong enough – Prime Minister Silvio Berlusconi’s government is falling apart and may not have the support to introduce planned reforms. In May-June, the spread between Italian and German bond yields spiked after the Berlusconi coalition failed to deliver, diluting the terms of three consolidation packages. Italy’s real problem is implementing reform, for it possesses the endogenous capacity to rebound.
What sort of trend are we seeing in Italy?
Berlusconi’s centre-right coalition is dogged by internal disagreements between the prime minister and Finance Minister Giulio Tremonti, and the Northern League’s fierce opposition to such measures as pension reform. President Giorgio Napolitano has tried to intervene.
Berlusconi’s resignation would not solve Italy’s fiscal problems. The problem is the inability of the political class as a whole to carry through genuine reforms, not who is in charge.
Do Greece and Italy face different challenges and what are they?
Italy could cover its debt from its domestic resources, whereas Greece and other smaller countries do not have the means to pull their economy out of the morass. Nonetheless, Italy’s problem is that investors are reluctant to purchase government bonds even though the ECB is intensively doing so, which makes refinancing operations much more arduous. Italian banks’ share prices have dropped and remain low. This has a knock-on effect on bank operations and lending, hampering economic growth.
How does the Italian public view the situation?
Unlike the Greeks, Italians have been more inclined to remember good times with the lira and have always been less enthusiastic about the euro, which for many has made life more expensive. In addition, Italian public opinion does not seem to realise what is at stake.
Are we facing potential bank runs in Europe? What indicators should we look at?
European finances are very interdependent. The problem remains capital flight as Greeks and Italians are moving capital abroad. This cash drain is hindering recovery.
The spread of Italian bonds over German ones is now over 400 basis points. Yet it is necessary to look at political indicators too. If markets perceive real political progress and sustained policy measures, the consequences would be very positive.
Has European leaders’ response changed recently?
In Germany, in the past four to five months, Chancellor Angela Merkel has adopted a more hands-on approach. Some lessons have been learnt. Help is needed in Greece, not punishment.
How close are we to a crisis as serious as that of 2008?
The EU is handling the crisis through the European Financial Stability Facility (EFSF), which has been criticised for not making enough hard cash available to encourage investor confidence. The ECB needs to be more involved. A Eurobond backed by euro-area states might stabilise markets and slow capital flight. The more activity from the political class, the greater the commitment by governments, and the more collaboration and pooling of resources, the better.
What is Mario Draghi’s role?
Mario Draghi’s first move as ECB president -- lowering interest rates by 25 basis points -- is a move in the right direction, towards stabilising financial markets. Yet the ECB must do more, for its Italian bond-buying programme has not yet stemmed the tide in the Italian bond market.
What is to be done?
An excessive ‘hair-cut’ on bank bond-holdings could have a depressant effect on several European economies. Especially in Southern Europe, tough austerity measures restrict growth and investment in reviving the economy. Hence, outside intervention is necessary in Spain and Greece, but not necessarily in Italy, where a balanced fiscal policy is possible. Smaller countries need external assistance, and the EU could provide macroeconomic policy coordination and better financial architecture to prevent capital flight, with Eurobonds halting the drain on capital, which is hurting economies further.
Will the EU find a way out of the sovereign debt crisis?
The EU’s ‘muddling through’ strategy will remain in place. Politicians are merely reacting, not acting pre-emptively under a strategic plan. Public opinion is becoming exasperated and the crisis is showing many unforeseen twists and turns.
The ECB wants to hand its bond-purchasing role over to the EFSF, but the latter has insufficient funds and the G20 failed to step in at its meeting in Cannes, because of the uncertainty and disarray introduced into euro-area policy-making by Papandreou’s referendum threat. Thus, macro-level vulnerability remains.
Is a new government in Greece going to obtain a clear mandate for radical change?
Instability is likely to remain, with governments succeeding each other every two years. The latest proposal for a caretaker government is only a short-term option. Leading members are expected to be not technocrats but members of the very political class that caused the crisis.
