For once Europe has an exit to celebrate rather than dread. On Monday, more than eight years after its first euro zone bailout, Greece left its third financial rescue program. This is a welcome Grexit, but before popping open the champagne it’s important to remember that Athens remains in thrall to its European creditors, who have failed to put the Greek economy on a sustainable footing.
Just three years ago, Greece’s amicable departure from any bailout program would have seemed unimaginable. In the first half of 2015, brinkmanship by Alexis Tsipras’s newly-elected radical-left government nearly precipitated a disastrous Grexit from the monetary union. After a hastily-called referendum delivered a resounding rejection of creditors’ terms for further assistance, Germany initially pressed for Greece’s temporary ejection from the euro zone. With Greek banks already shut down, Tsipras ultimately folded, agreeing to sweeping new reforms. But even then the future of the new deal seemed uncertain.
Greece and the euro zone dodged the worst of the possible outcomes that loomed during their extraordinary clash in 2015. But the fault lines remain. The euro area was desperate to avoid a fracturing of the currency union; any exit at all would call into question the supposed irrevocability of the euro, prompting financial markets to bet against other struggling economies. On the other hand, there had to be some way of disciplining a country that sought to exploit this underlying flaw.
That flaw arose because the euro area was supposed to be a monetary union pure and simple, without any fiscal ties or support. This wishful thinking did not survive its first reality check when Greece lost access to the financial markets in the spring of 2010. Euro zone countries hastily discarded the “no bailout” edict in the 1992 Maastricht Treaty setting out the ground rules for the single currency. In a convenient legal reinterpretation of the treaty, bailouts turned out to be possible after all – as long as they took the form of loans rather than outright cuts in debt.
That is the source of Greece’s continuing plight. Though the country is emerging from the bailout program, it remains beholden to its euro zone creditors and the huge loans they have made. These account for the lion’s share of its towering public debt which, at 180 percent of GDP, is the highest in Europe. (Only Japan has higher debt as a share of GDP but, in a crucial contrast with Greece, Japanese themselves – rather than foreign creditors – hold the bulk of it.)
High public debt makes countries vulnerable to the whims of markets. They must be on their best behaviour to ensure access to private sources of funds, and even then they can fall foul of mood swings when investors lose their appetite for risk. No longer shielded by the bailout program, Greece will have to tap markets again to refinance its existing debt as official loans mature. That is why, in an ideal world, Greece would leave its third bailout with much lower debt, through a direct reduction in the face value of the euro zone loans.
However, any such “haircuts” are anathema to European creditors who have guilty consciences about riding roughshod over the no-bailout rule, and who fear a taxpayer backlash against explicit losses on loans made to Greece. Instead, the euro zone has long pursued a stealthy policy of debt relief through other means. Interest rates which were initially punitive are now as low as possible and interest payments are deferred on a big chunk of the lending. Maturities of the loans have been extended and stretch out for decades. The Eurogroup of finance ministers dished up a further helping of these remedies in June when it paved the way for Greece’s exit from the rescue program.
This “extend and pretend” approach will provide some shelter from the markets over the next decade or so, but keeps Greece in hock for much longer. For euro zone creditors who fear that Greece may resume its bad fiscal habits, this may seem like an advantage, since it allows them to exert influence even as their direct control through the bailout program ends. But it is a recipe for simmering disaffection, as Greece must run primary (before interest payments) budget surpluses not just for the next few years, but until 2060.
Such an unprecedented endeavour would be inauspicious at the best of times, but it follows the worst of times. Along with the burden of debt, there is a heritage of bitterness on both sides. Northern creditor countries blame Greek fiscal profligacy for the country’s woes. Greeks blame their rescuers for the austerity and unpopular reforms that they have had to endure.
As things stand, an economic miracle – a sustained period of rapid growth – is necessary if Greece is to escape its debt shackles. Since GDP has fallen so far – it was a quarter lower last year than in 2007 – a bounce-back might appear feasible at least in the short-term. But projections further ahead are discouragingly low, suggesting that Greece will not be able to grow its way out of trouble. The IMF projects long-run real GDP growth of around 1 percent a year. Even this meagre estimate may prove optimistic; Greece faces particularly unfavourable demographics as aging shrinks the working-age population.
The euro area’s unwillingness to face truth and to write down some of its lending to Greece is misguided. Its policies are set to keep Greece in a prison of debt for decades to come, with the euro zone creditors as its jailers. This is not the way to forge a new and happier relationship between the euro area and its prodigal child.