As if Italy and Brexit weren’t challenging enough, the European Union will soon have to deal once more with Greece and its debts. The country is due to leave its third economic adjustment program this summer. After nearly a decade of support from its euro-zone partners and the International Monetary Fund, Greece and its creditors are hoping that it will soon be able to function once more like a normal economy.
Without further moves on the part of Europe’s governments, that hope is likely to be disappointed. Greece needs further debt relief, well beyond what the creditors have contemplated so far.
The country’s public debt still stands at roughly 180 percent of gross domestic product, even after the sizable write-down of government bonds in 2012. For now, Greece benefits from exceptionally long maturities and low interest rates, making the debt look affordable. This is misleading: In almost any plausible economic scenario, that enormous debt ratio is not set to decline enough. As long as that’s true, Greece’s debt problem remains unsolved.
Europe’s governments know they’ll have to do more. They’ve agreed in principle to soften the terms of support from the euro zone’s rescue funds after 2022, so long as Greece maintains a budget surplus (excluding interest payments) of 3.5 percent of GDP until 2022, and a surplus of 2 percent or more after that. Such a prolonged fiscal squeeze is virtually unheard of. But even if Greece could manage it, the numbers still wouldn’t add up. What’s been suggested so far simply isn’t enough to get the debt ratio on a sustainable and credible downward track.
Europe’s governments have raised constitutional objections to an outright reduction in the face value of debt, but these could probably be overcome so long as the reduction were granted in exchange for new commitments on Greece’s part. A bargain like that could persuade voters in other countries to help Greece one more time. And it’s needed, as well, to encourage Greece to renew its efforts to control public spending and raise the economy’s slumping productivity.
For example, as suggested by economist Barry Eichengreen and others, governments could tie continued fiscal discipline to explicit debt reduction: For every increase in the primary budget surplus above an agreed minimum, there’d be a measure of further debt reduction, promised in advance. The math could then be made to work. The right mix of moderate fiscal discipline and debt relief would be enough to push the debt ratio down credibly.
This would go a long way to reassure investors — yet it still might not be sufficient. Greece also needs a safety net in case of a new liquidity crisis. One good way to provide it would be a so-called precautionary credit line from the European Stability Mechanism. Greece’s government doesn’t like the idea, because it wants to declare a “clean exit” from its financial troubles this year. That’s misguided: Unless the debt ratio comes down and Greece is sure of adequate liquidity in the event of any new crisis, any such declaration will be worthless.
A credible plan to restore Greece’s finances is long overdue. This summer, the problem needs to be solved once and for all.