Greece requires even more debt relief than that suggested by the NIESR

by Shaun Richards
It was only on Monday that I analysed the grim survey that Markit had undertaken on manufacturing in the Greek economy. Its analysis of the situation in July led to the lowest reading it has so far calculated for it (30.2 on a scale where 50 is unchanged) which is quite something when you consider the economic depression which has been raging there. This morning the UK NIESR (National Institute for Economic and Social Research) has released its view on what will happen next in the Greek economy.

The economy is expected to contract sharply again this year and next, with GDP falling 3 per cent in 2015 and 2.3 per cent in 2016. We expect the recession to end in mid-2016.

It does not make for happy reading especially if we put it into the overall context.

 At this point the economy will be more than 30 per cent smaller than at its peak in 2007 and smaller than when it joined the Euro Area in 2001.

Actually the Greek economy fell below the level it had entered the Euro a couple of years ago so it would be more accurate to say even further below the level at which it joined the level. Also the NIESR omits to point out that under its own definition of a depression Greece is not only trapped in one but escaping it seems unlikely this decade and maybe beyond that.
The economic effect of raising VAT
I have been very critical of the new austerity plan partly because the recessionary effect of raising indirect taxes such as VAT is now known because of what has happened. The NIESR has investigated this.

“The changes to the VAT system will hit already weak consumer spending, shrinking the economy even further this year and next. It will also mask some of the underlying deflationary pressure this year and next.”

Putting this into numbers they estimate that consumer spending will see a small nudge lower this year but the main impact will be falls on 1 to 1.5% in both 2016 and 2017 and 1% in 2018. Actually this will make the deflation problem worse and it is the disinflation which will be reduced by price rises which may add as much as 2.5% to consumer inflation in 2016. The ordinary Greek consumer facing higher prices is likely to consume even less and the whole downwards spiral starts one more time.
What about debt relief?
The IMF suggested that a large effort would be required in this area.

If Europe prefers to again provide debt relief through maturity extension, there would have to be a very dramatic extension with grace periods of, say, 30 years on the entire stock of European debt, including new assistance.

However the NIESR has gone further suggesting that even such a move would not be enough.

According to our modelling, restoring debt sustainability requires a debt write-off equivalent to at least 55 per cent of GDP, higher than the IMF’s estimate of 30 per cent……Restructuring, or writing off, €95 billion (55 per cent of Greek GDP) provides Greece with, at least, a chance of lowering its debt stock to the target levels of the original bailouts (around 120 per cent of GDP in 2020). More could be done.

Thus we see that just as the Euro area plans a new bailout of 85 billion Euros it faces the prospect of having to write-off an even larger amount! Actually they are more likely to do anything like this by fulfilling one of my themes from the beginning that the maturity dates of the Greek date will head towards infinity. Or to use my financial lexicon they will be “temporary”.
Monetary Union
The NIESR touches on another theme of this blog which is how monetary unions normally behave. If we look at the UK as one I have pointed out in the past that the weaker areas (or our equivalent to Greece) are supported by regional policies where funds are switched to support them and investment there is encouraged. For example the Nissan plant in Sunderland is a successful example of this. Actually even in relatively successful currency unions like the UK the amount of regional policy is invariably not enough to solve the problem but in one where national identities and treasuries are still strong it is even less likely.
The NIESR suggest that the following would be a better solution than those suggested so far.

The fiscal transfer from Euro Area members required to achieve this would represent 1 per cent of Euro Area GDP in one year. As it would be spread over many years and across the membership, we argue the impact on other Euro Area members would be minimal, and that this fiscal transfer is necessary if Euro Area membership is to be maintained.

Except we are back in the usual mess of trust and honesty and doubt over how much reform Greece has actually undertaken. Also such a move would have a real cost and have to be accounted for rather than being kicked to off-balance sheet organisations like the ESM and EFSM. I checked the situation for the UK’s involvement in the EFSM and we do not account for any funds guaranteed unless it is lost, so one day we may get a “Surprise,Surprise” type announcement.
The Banks
The opening of the Athens Stock Exchange has led to this for the Greek banks. From Kathimerini.

Greek banks extended a rout that has wiped out more than half their value this week, sending the nation’s stocks lower for a third day….An index of Greek banks has fallen to its lowest level since at least 1995.

I note one comment being Simply Red. The short-selling ban is not going so well is it? But if we look at the impact of this on the Greek economy we see that it continues to be a noose around its neck. From Macropolis.

More than half of small Greek businesses saw turnover dive by at least 50 pct due to capital controls.

Ironically the bank deposit situation has now stabilised and even improved a little according to leaks which suggest a 1 billion Euro net inflow since July 20th re-opening of the banks.
Comment
There is one rather odd part of the NIESR report.

While the establishment of a new currency in Greece is clearly fraught with risks, there may come a point where the calculus simply no longer favours remaining within the Euro Area.

Fraught with risks yes and the current situation is not? Also there is the risk of success! But the oddity is that the fact is that due to the continuing economic destruction being inflicted on Greece it is a case of the sooner the better in my opinion rather than waiting for some better day to leave the Euro.
Also whilst the NIESR analysis require more debt relief than published elsewhere the truth is that even it does not go far enough. The 120% target for the debt to GDP ratio only existed to avoid embarassing Italy and Portugal and Greece needs to get back to 100% as a maximum.