Pacifying bond vigilantes (bondholders who punish nations for having weak monetary or fiscal policies by selling government bonds), has been Greece's biggest strategic nightmare ever since Prime Minister Papandreou announced the acceptance of a bailout package of 110 billion euros this time last year. The entire year has gone by in efforts to assuage its citizens and the markets, while both are unequivocally unhappy about the slew of austerity measures imposed by the government. What the Greek government has failed to acknowledge is that there is an overpowering interest present in the bond markets which is making continued membership of the European Monetary Union nearly impossible. The ancient Chinese strategist Sun Tzu noted in 600 BC that "there is no instance of a nation benefitting from prolonged warfare", and this holds true for the Greeks, who have so far deluded themselves into believing that holding a brave poker face long enough will somehow buy time to get out of their existing economic mess.
The return on the Greek 10-year bond is hovering around 15 percent which when compared to its historically stable German counterpart, the Bund, which is yielding a little over three percent for the same maturity, seems unmistakably unsustainable. Furthermore, the returns on the shorter term Greek debt signal that the markets are in no mood to wait for dithered decision making. Simultaneously the cost of insuring the sovereign debt is also at record levels (according to CMA prices for credit default swaps). The yield on the 3-year Greek bonds is around 21 percent, while the negative GDP growth in 2010 of -3.3% indicates that there are only socially undesirable solutions left since slow economic growth is clearly going to be of no immediate help.
Greek economic growth has suffered a huge setback since it joined the Euro area and the loss in competitiveness caused by the inherent restrictions of joining a currency union is something that the economy never recovered from. This whole process has been exacerbated by the global financial crisis that for economic survival; has highlighted increased efficiency and productivity like never before. Although measuring competitiveness is not a clear cut task, both for economists and statisticians, all studies have indicated that in Greece it has suffered considerably, especially wage competitiveness. Earlier last month, IMF chief Dominique Strauss-Kahn said that a decrease in "public sector wages" was the key for restoring growth in the Greek economy. Given that the public sector wages have risen by over 100% since the Greeks joined the euro, this is a fair point. However, considering that public sector workers have already lost many months of wages and incurred cuts in their pensions following the acceptance of the terms of the EU-IMF bailout last year, the strong roots of patronage politics in the country will hardly allow more room for forced austerity going forward. A majority of economists agree that a debt to GDP ratio above 90% is negative for economic growth, since key resources are diverted away from productive uses and are used for unproductive interest payments. With the debt to GDP ratio of 140 percent in 2010, there is little doubt that the Greek economy is left with little room to manoeuvre.
On April 14th this year, the Greek government reiterated that it is not considering restructuring of its debt, which is a less crude way of saying that there is no imminent possibility of debt default. However the slump in Greek bonds tell a different story, and sure enough a few days on, Greece has asked for a 45 billion euro safety net from 15 EU countries to prevent default. With the imminent meeting of the European Central Bank policymakers on May 5, the Greeks may as well see that victory lies in admitting that there are serious problems that cannot be solved by overconfident rhetoric aimed at market manipulation. The markets are hungry for assurance and fast action, which ironically are the exact ingredients that have been missing in all post-crisis decision making in Europe, whether in the case of Greece, or any of the other troubled "peripheral economies". Policymakers should also pay heed to the lessons of the recent past, which dictate that bail-out packages are not permanent cures, and if the problem is serious and deep rooted, as in the case the Greek economy, severe long lasting solutions are required even if palpably more painful.
The negotiations for financial aid are certain to be mired by a lack of trust for Greece's ability to commit to tougher and longer austerity packages than before. Germany, the 'trust fund' of the euro-zone, is getting increasingly impatient with regard to bailouts. Chancellor Angela Merkel is going to be extremely cautious in dealing with the German response to the requested money ahead of the regional state election on May 9 after already suffering heavy political setbacks due to the emergence of such post-crisis issues. The recent Finnish general elections are also certain to have an impact on the negotiation process. The True Finns party, which won the second biggest number of seats, are staunchly against EU bailouts, and are likely to be given a bigger role in the next government. According to EU rules, no country can be offered a bailout without the consent of all the members, and with political parties in Europe increasingly turning hostile to the idea of supporting the economically diseased members; bailouts are not going to come easy in the future. In Finland, parliamentary approval is required for supporting bailouts, and this is likely to also impede the pace at which Portugal negotiates its 80 billion euro rescue package.
There cannot be general blanket solutions to the problems in the euro-zone and European policymakers seem to be taking an awfully long time to realize this. Every time a member nation is in trouble due to the unsustainable condition of its sovereign debt, the same few steps seem to be repeated. Initially there is always strong denial in attempts to confuse market participants, followed by talk of bond haircuts and fiscal austerity inevitably followed by the acceptance/deliverance of a bailout. In the event that a Greece or a Portugal were to default, and therefore be excluded from participation in the markets, the costs on the euro area's collective credibility would significantly outweigh the benefits of imposing stricter fiscal discipline. This cost-benefit balance will not remain so forever, and the existing structural problems in countries like Spain and even France, would necessarily lead to some re-examination of the prescriptions used so far. From a Greek point of view, although unlikely due to the aforementioned cost benefit analysis, a default might force the country to look inwards and make the required long term changes to rejoin the markets when on a sustainable debt trajectory.
(Vivan Sharan is an Associate Fellow at Observer Research Foundation)
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