Greek debt crisis: what happens now?

Here we go again. A new impasse between the International Monetary Fund and Greece's European creditors has raised once more the threat of “Grexit.” The IMF considers Greece’s debt, currently at 180 per cent of GDP, as unsustainable. It has therefore refused so far to take part in the country’s third bailout, agreed in July 2015, unless the European creditors offer debt relief. The Europeans are unwilling to write off debt ahead of national elections—when voters do not want to be told their taxes are going to help the Greek politicians.

The only other option on offer is even greater austerity to force Greece to aim for large primary surpluses in its yearly finances. This requires additional measures which the current left wing Syriza government, run by Alexis Tsipras, would have difficulty accepting.

There is a crucial Eurogroup meeting on Monday, 20^th February which should—in theory—pave the way for a successful completion of the current review of Greece’s progress, and release a further chunk of money as some €8bn of loan and bond repayments are due this summer. But it may not. And the Dutch are saying that without IMF participation the whole bail-out is in doubt. The Commission has sent Pierre Moscovici, the EU’s economic Commissioner, to urge the Greeks to find a compromise solution. Without it, default or exit from the euro—maybe even from the EU—could follow.

Why do we worry so much? Greece is, after all, a small country accounting for less than 2 per cent of the eurozone’s GDP. But at the heart of the current impasse is what Greece's travails tell us about the euro project itself. Was Greece's euro participation a unique mistake that can be sorted out by cutting the country off the euro and letting it drift? Or is it part of a wider malaise that needs to be sorted out?

That Greece has done particularly badly under the euro is undisputed. But eight years on since the financial crisis, with the country unable to devalue or print its own money, GDP is 25 per cent down, the unemployment rate has stubbornly remained at over 20 per cent, youth unemployment has rocketed to over 50 per cent and the young are leaving the country in large numbers. The enforced internal devaluation though falling wages has done very little to increase the country's competitiveness.

There are still capital controls in operation which are restraining business activity and consumer spending. There is a serious humanitarian crisis, the percentage of the population at or below the poverty line has risen alarmingly, property values have collapsed and VAT, income and other taxes have been raised repeatedly to improve government finances. It is now obvious that the IMF-inspired policies imposed on Greece were counter-productive.

Last year saw some improvement. Tourist inflows rose strongly as Greece benefited from the geo-political tensions elsewhere in the Mediterranean region. And there was progress on the fiscal front as Greece managed to achieve a much larger primary surplus, excluding debt servicing, than was expected. But the latest data for 2016 suggested that the economy surprisingly contracted in the last quarter, and that GDP fell slightly in the year as a whole.

So what happens next? The good news for Greece is that the latest upset may have come at a propitious time. This is a year when the Brexit negotiations are meant to be starting in earnest. Europe has also to deal with a continuous migration crisis, increased security concerns, the rise of populism and verbal attacks from President Donald Trump. The main hope for Greece therefore is that the Europeans, mindful of the need to keep the EU together and present a united front, will want the euro project to survive at any cost. Greece is worth keeping in rather than kicking out, as the latter option would rock the boat. But a compromise in the short term to keep the show on the road—and stave off renewed political uncertainty in Greece itself, will have to give way to more fundamental debt restructuring and/or write-off in the future that seriously reduces Greece’s debt burden and allows growth to resume. Whether that will be good enough to keep the IMF engaged of course is not clear.

But the real worry for Europe is that Greece is only a rather more extreme example of the issues afflicting the eurozone more widely. Growth in the single currency area has generally disappointed, the economies haven’t really converged and debt to GDP ratios are too high in other countries too. Italy’s is at 132 per cent, Portugal’s 130 per cent, Ireland’s 120 per cent, Spain’s is nearing 100 per cent.

The truth is that there is more at stake for Europe than what happens to a small country at the edge of the continent. With Brexit also on the horizon, what the eurozone needs is a clear rethink of its economic governance, along with institutional structure, if it is to in future spread whatever benefits were promised from euro participation more fairly across its members.