Greece strikes a deal but at the end of it she is unlikely to be solvent

Yesterday Sunday the 2nd of May saw some significant changes in the likely financial future of Greece and by implication also the euro zone and the International Monetary Fund (IMF). I rather suspect that these matters will be debated for some time as I can already see implications both intended and unintended which stretch into the future. Sadly this future includes the period after the term of this aid package. The details which came out gradually through the day (has no-one told these people that you look more efficient and competent if you realise it all as one package?). In terms of details we got an austerity package for Greece which is estimated at 30 billion Euros in terms of size (more than the 24 billion trailed) and a combined euro zone/IMF aid package of 110 billion Euros (less than the 120 billion leaked at the Bundestag last week). 

Greece’s Austerity Package 

The Greek government has released a summary of the austerity measures which it will now impose as part of the conditions imposed by the euro zone and the IMF. 

Spending Cuts 
1. The 13th and 14th month salaries for public employees will be eliminated for those earning over 3000 Euros a month and capped at 1000 Euros for those earning less than this.
2.In addition,  public sector salaries will be frozen until 2014 and allowances (another income stream for public employees) will be chopped by  8% which in fact is in addition to the 12% announced by Greece’s own austerity programme announced earlier this year.
3. The  13th and 14th “holiday” payments to pensioners will be reduced by an amount which is estimated to save 1.5 billion euros in 2010.
4. Public investment plans will be cut by 500 million Euros in 2010.

1.The main VAT rate will increase by  2% to 23% which adds to the increase announced in March of 2% to 21% and excise taxes on fuel, tobacco and alcohol will increase by another 10% as they too were also raised in March. 
2. There will be new taxes on properties and the gaming industries; Private companies will have to pay a one-off tax on 2009 profits which will be as well as  a similar levy six months ago on profits from the previous year. 
Structural Policies 

There are some planned structural policies to try to increase Greece’s growth rate. These include a liberalisation of labour markets by ending the current law which stops companies from laying off more than 2% of their workforce each month. There is a plan to liberalise the energy and transportation sectors. The state pension system will also be modified with rises in the pension age which may well be linked to life expectancy and increases in the level of contributions to the scheme.Also it will switch to a career average rather than a final salary type structure. 

The Impact of this 

This is a severe and deflationary package and the official forecast for economic growth over this period is that  Gross Domestic Product will shrink by 4.0% this year,  which will be followed by a further shrinking of 2.6% next year, and then there will be actual growth of  +1.1% in 2012 and +2.1% in each of 2013 and 2014. Should this (rather fanciful) scenario actually take place then Greece’s ratio of national debt to GDP will peak in 2013 at 149%, and will then decline to 144.3% in 2014. Even under this rose-tinted forecast there are disturbing implications for this level of national debt and I shall return to these later. 

The implied levels for the fiscal deficit have it falling from 13.6% of GDP last year to 8.1% of GDP this year,and then 7.6% in 2011, and then 6.5% in 2012, 4.9% in 2013 and  2.6% by 2014. 


There are several things obvious from these numbers that are clear to me. 

1. The forecasts for economic growth are very optimistic. I was expecting Greece’s GDP to fall by 4% this year before these new austerity measures were implemented and I would not have been surprised to see a 2/3 %  fall next year. These were already numbers which if they turned out to be wrong would have been on the low side I feel. With the new austerity measure I think that Greece’s economy could contract by 6% this  year and by 4% next. 

2. Even with these very optimistic forecasts Greece’s ratio of national debt to GDP is expected to peak at 149% of GDP. This is a high figure and means that to finance her debt her economy will have to grow at 1.5 times the interest rate she is charged on her debt to stop her situation deteriorating . I would just like to say that this is just to stop it deteriorating as  there is no mention of any improvement for this to take place she would have to grow more quickly. 

3. A sign of how dependent these numbers are on rates of economic growth (which sadly in this case are contractions rather than increases) is that Greece’s fiscal deficit under the new austerity plan is forecast to fall below 3% one year later than under the EU/Greek plan announced earlier this year. The factor which has changed is that growth forecasts have deteriorated and this means that in terms of a fiscal deficit flight path even increased austerity measures cannot fill the gap. 

4. Now if you put my more realistic forecasts for economic growth into the national and fiscal deficit forecasts above I think you can come to only one conclusion. At the end of this plan Greece is likely to be  insolvent. 

It is not impossible that Greece will escape this conclusion just very unlikely. After all someone might in the next couple of years discover a way of actually creating power by cold nuclear fusion and thus boost the whole world economy. But under this plan something like that will be required. In essence yet again reality is being postponed and delayed rather than changed. 

The EU and IMF 

In return for the plan proposed above then Greece will receive around 80 billion Euros of loans from her euro zone partners and 30 billion euros from the IMF. This is a lower amount than trailed and is some 25 billion Euros less than I thought would be necessary as I feel that if you have what is in effect an ammunition store you must never let the prospect arise that it might run out. Imagine the chaos if such a situation did play out. 

The state of Greece’s banking sector 

Something must be very wrong and it is quite possible that I have underestimated the implications when I wrote on the about the way that Greek banks looked in trouble on the 19th and 28th of April. You see the aid package has two features which make me think this. 

1. Euro zone officials said that  €10bn of the package could be used as a potential stability fund for the financial sector in particular. 

2. The European Central Bank (ECB)  said on this morning (Monday the 3rd May) that it was suspending the minimum credit rating required for Greek government-backed assets used in ECB liquidity-providing operations “until further notice”. The move removes the risk of Greek government bonds being excluded from being able to be used as collateral for (cheap) loans from the ECB  if ratings agencies should downgrade her status further. 


Taking as a whole these are very revealing measures and suggest that the situation may well have been rather dire. Otherwise why do this? 

Not only Greek banks will be helped as remember French and German banks in particular were holders of Greek assets/debt on a substantial scale. 

This is another loss of credibility for the ECB as it had an opportunity to change its collateral rules only a fortnight ago and did not take it. So it cannot avoid the accusation of a short-term “panic” measure. 

The IMF 

I have written before about how the role of the IMF is being changed by this crisis and would refer you to my question posed on the 26th April . However whilst its size is being expanded its role has also changed. If you look at its website it has a factsheet explaining its role. 

A member country may request IMF financial assistance if it has a balance of payments need—that is, if it cannot find sufficient financing on affordable terms to meet its net international payments while maintaining adequate reserve buffers going forward. An IMF loan provides a cushion that eases the adjustment policies and reforms that a country must make to correct its balance of payments problem and restore conditions for strong economic growth 

Greece does have a balance of payments problem but I doubt if there is a single sane person who believes that is its main current problem so we have one more change from the crisis a new (politically convenient) role for the IMF. 


The measures presented above do help Greece with her current liquidity crisis. But as I have described above they do not help her with her solvency problem. Should her economic growth disappoint over the next 2/3 years, and there are grounds for supposing that they will, then this package will make her position worse and she will be less solvent at the end than at the beginning. 

For all the rules which are being ignored or watered down leading to a decrease in credibility for the EU nad its institutions I do not feel that this will prove to be a good trade-off. 

The actual implementation of all of this has its own risks. As of the end of last week only Cyprus had made real strides in terms of actually approving its share of the proposed loan for Greece. So again action has lagged talk. This is before we see the inevitable submission of this aid package to the German Constitutional Court or perhaps what view the electors of North Rhine Westphalia express on the 9th May. Of course now the plan is larger than the one which not a lot of progress was being made on… 

The weaker nations in the euro zone will have to contribute to this package and this will lead to a deterioration in their position. I am particularly thinking of Portugal and Ireland here but they are not alone.


25 thoughts on “Greece strikes a deal but at the end of it she is unlikely to be solvent

  1. Hi,

    Nice article. It reflects reality too. All I know after the measures taken and the (probable) future measures to be taken in 2011/12 (or even later this year if we’re unlucky), is that I’ve made up my mind.

    Sometime on 2011 at most, I will emigrate elsewhere. The exact timing will vary, but ideally I’d like to have 2 years of work experience following university under my belt (which I will, in Dec 2010).

    If I am made redundant earlier on for some reason, I’ll take the plunge earlier on.

    If I decide to go back to UK (which I left in 2007 following my studies), I’ll be happy to drink a pint with you fellow-readers 🙂

    There is an underlying sense that people <30-35 share these beliefs. We'll probably make 2010 the new 'era of emigration' after the 60's. Yay us.

    "Kalo kouraghio", as Oli Rehn said…

  2. Shaun,
    Objective analysis in my opinion (not like the BBC’s articles). I agree with the conclusions also. I think as you said from the beginning if the process does not involve a severe haircut along the way won’t work. It will be covered partial default. I think this is the only realistic option. Otherwise, Greece will become insolvent in a couple of years.

    • Hi Basil and Ioannis
      Thank you for the compliments. I do not take any pleasure in my analysis as it is quite possible that things will actually get worse and I do not wish for that. As to the BBC it is always worth pointing out your views on their blogs etc. and you always have the option of suggesting there are places which look at things more analytically and rationally…

  3. I still see the key problems as the Greek people mostly continuing to state that they will not accept the pubic spending cuts and austerity which go with this announced deal, and a lack of specific commitment on the part of the other key countries (particularly Germany), and except perhaps Cyprus ! So it seems to me that the likely outcome now is riots on the streets in Greece with significant damage perhaps being done and loss of life, and a continuing saga of unreal commitment on the part of the key EU nations as before, and that this will ultimately be just another game of words?

    For Germany to actually deliver the necessary funds will evidently require court action and there is already much resentment amongst the German people to make these funds available to Greece effectively from German taxpayers. It seems to me that the hurdles still to be passed are too difficult. Will the markets continue to provide funding for the duration it will take for political words to become specific fiscal action and funding? It could still transpire that before the EU/IMF bail-out is physically provided Greece will become pragmatically insolvent?

  4. Hi there,

    Interesting article – I’m a producer on a a global phone-in/discussion show called ‘World Have Your Say’ and I’m hoping you can please help me out.

    Today on the show we’re discussing the financial crisis in Greece, the agreed bailout by the EU/IMF and the austerity measures the country will have to go through as a result. There’s not a lot of sympathy across Europe for the Greek people, especially given the way they’ve been rioting on the streets and many feel they’re not being grateful for the bailout. However, it’s my task to find some people who can relate to the Greeks, feel some sympathy for them and can understand the frustration in the country – particularly for the ‘everyday people’.

    Do you, yourself, feel some sympathy for the Greeks – or do you know people who do? We’re keen to get some people across the world who can empathise somewhat with the Greek people’s predicament.

    Do drop me line if you want to know more or think you can help out,

    Many thanks,


    • Just to put things in the proper context. So far,
      there has been no real riots etc. in Greece. What you see on 1st May etc. has always been hapening every so often. In Greece there is a small minority of very militant anarchists which create such incidents very often. Also, the left party activists traditionally protest for about everything and march in the streets of Athens every week or so. So, there has been no real opposition to austerity measures so far. People are more numb resigned and desperate than anything else. They see no alternative. Of course, things might change in the future and we could see extensive rioting even a popular uprising. No-one can exclude that. Myself, so far I am suprised at the lack of proper opposition to measures in the streets and intellectually. This is what surprises me and I would investigate. Not the opposite!

    • Dear Mick,

      I have stated my views to BBC and here – You should keep in mind that the “riot climate” the international media are keen to portray does not really exist. As Basil said before me, there are certain “wings” (leftist, in their majority) that produce the colourful images displayed on the BBC news website, et al.

      You can quote me on this: The average employee does not wish to oppose the EU or oppose the IMF measures. They are far angrier towards OUR OWN political system for bringing us to this deadlock, than to the EU / other bodies who decided to assist.

      Of course, the portrayal of the media here of the Germans in particular as ruthless tyrants who refuse to provide their assistance because of self-interest (electoral or otherwise) certainly does not help the situation. But don’t think that ‘the so-called riots’ are a notable phenomenon.

      The December 2008 RIOTS in regards to Alexandros Grigoropoulos murder by the police? Yes, they were riots. The situation in 2010? 10 times milder than that.

      Keep that in mind, if you will.


      Ioannis M.

    • Ioannis and Basil,

      I understand taking issue with the portrayal of the protests by a few as “riots”. The issue however is how come a few people can shut down hotels, ports, even national borders — because as you point out they are just a few, representing what we can affectionately call “special interests”.

      How is the economy of Greece going to be able to flourish to improve the lives of its people under the circumstances?
      The farmers shut down the major national highway and the border with Bulgaria a few months ago, violating major laws and affecting the livelihoods of many.
      The port workers shut down the Pereaus port protesting the deal ceding management of part of the port to a Chinese company — again, bringing businesses to the brink of bankruptcy and forcing companies to change their routes.
      Hundreds of spanish tourists were stranded a few weeks ago because they were blocked by protesters and could not get on their cruise ship in Pereaus.
      Heck, a few months ago former employees of Olympic Airways occupied the budget office and the vice minister of finance (Sachinides) could not go to his office, all in the midst of very serious economic circumstances for the country.
      Not to mention the threats by the tax collector and custom officer unions not to do their jobs if their salaries and perks were affected by budget cuts.
      Or the blackouts by the Electricity company employees. Or, or,… (the icing on the cake was the recent work stoppages by the Airforce pilots).

      What’s going on? Can any special interest group shut down economic activity and everyday life to blackmail the government?


  5. This ain’t about saving a country and its people from the desperation of insolvency and bankruptcy; it’s about keeping the banks at the playing tables of the ‘no lose’ Casino d’International with Trichet as croupier!

    • @Mac
      I actually agree but Greece cannot do a revolution alone against the global system. Greeks are already branded lazy etc.. I think this will work only if the masses in other countries realise what is really hapening. Within the system what Shaun says is right. Above and beyond the system what you say is correct and it is pretty pathetic. Bankers, politicians and super-rich oligarchy against the people all over the world.

    • spot on Mac. That’s all it’s about. Politicians have not character or decency. But there is no holding back the tide. Eventually the flood will cover all. You can’t cheat economics.

  6. Enjoy the blog. As an economic novice, I have a question:

    At the end of the period, Greece will still have a fiscal deficit. At no point is a surplus mentioned, so they borrow 110 Billion Euros, add it to the existing debt, and then borrow more? My understanding is that deficit debt is reported as a annual figure, not as accrued, How can they possibly be solvent, ever at this rate?

    • Hi John and wellcome

      If I took this as a theoretical question then I could sit down and calculate a theoretical growth rate for the Greek economy which would fix this situation. If you have a debt it can grow as long as the amount you produce grows faster. Coming back into the real world this is why I emphasise economic growth rates in my article. This is because moving them downwards as the euro zone officials have done this weekend has had quite a big impact on the numbers for fiscal deficit and national debt as time goes by. The effect has been that a more severe austerity package now takes a year longer to get where the previous one got too.

      Now if you use my expected growth rates Greece is likely to emerge at the end of the 3 years of this package weaker than at the beginning. Something will have to change quite fundamentally for it to work which is why I highlight the example of cold nuclear fusion.

      In the past debt problems have also been solved by inflation but this would make Greece less competitive unless everyone else has inflation too…

      So your question has troubled me through this crisis which is why I have suggested a package of measures including a debt restructuring or “haircut”.

      • Hi Shaun, surely Greece would only be able to use inflation (as the UK) if the European Central Bank generated it? This is the problem which Greece has; it cannot generate its own inflation because it is in the Eurozone?

        • Hi Drf
          Yes I agree. I was only using it as a theoretical example. In reality of course some parts of the Greek economy need inflation as it would reduce the real debt burden. However as she also needs to improve her competitiveness she also needs falling prices in price competitive sectors as well as falling wages and so here inflation would be a exactly the wrong thing.

          However in the short term she is likely to get a burst of inflation due to her increases in VAT and the effect on $ denominated commodity prices of the fall in the Euros exchange rate. In my view this secondary effect of what is happening (higher inflation) has not been thought through and considered at all by those with the aid plan.

  7. Hi Shaun,

    Excellent posting as usual.

    Quick question re IMF. Will the involvement of IMF in Greece’s budgetary issues not automatically lead to restructuring of debt and haircuts, as well as fiscal reorganisation? I assumed use of these tools were givens … ?


    • Hi Micklaus
      Everyone connected with the aid package is denying the prospect of any haircuts or restructuring and this includes the IMF. It would appear that the euro zone is still pretty much in charge with all the dangers of political meddling which is entailed by this……… As I have stated before the IMF is far from perfect in its operations in my view but as an experienced organisation it is likely to do a much better job than the EU.

      If I had been in charge of the IMF I would have insisted on primacy and freedom of action.

  8. Fantastic analysis as always. Thanks.
    Another question or two.. (Sorry)

    Im intrigued by the ECB’s offer to continue to accept Greek Govt backed assets, no matter how poorly they are rated. Ultimately any “haircut” on those same assets will then be suffered by the ECB.

    Presumably over time (and as Greece looks more and more likely to be nearing default) what is to stop all EU banks dumping their holdings on the ECB simply in order to avoid the “haircut”?

    Also, (sorry for this one, I too am a novice), how much liquidity can the ECB provide? How is that liquidty controlled and ultimately who loses out if the ECB suffers a haircut on its holdings? Im guessing its the EU taxpayer somewhere down the line?

    • Hi Zak
      If you think of it logically the ECB probably has a lot of Greek government debt as assets pledged as collateral for loans as they have been the highest yielding of the euro zone bonds. It would have been the most profitable trade.

      The banks would still be liable for the haircut not the ECB, so problems only really come if the banks start to fail.

      Liquidity is a different question as the ECB could in theory supply as much overnight money as it likes. However if you regard these loans as a type of liquidity support operation there is still no upper limit as such.

      So actually your problems only really start if we begin to see bank failures caused by this. As several components of the aid package in effect support the Greek and European banking sector then the questions you have asked have been troubling the ECB too!

  9. “Do you, yourself, feel some sympathy for the Greeks”

    Indeed I do.. they’ve been led to believe by their government that living beyond their means and borrowing endlessly would be allright in the end, and now the Greek people, who simply believed their own politicians, will pay a fearful price over the next decade for their goverment’s incompetence and outright lies.

    Not to beat a dying horse, but again one cannot solve a problem of debt with more of it. This is sheer absurdity.

    • Let us hope that the German courts do for the Greeks what their own Government is failing to do by ruling the bailout unlawful and forcing a default. It would be the best outcome of a bad situation for the Greek people it seems?

  10. I don’t know if the 110 Billion is enough. Maybe that number was taken to satisfy the markets and politicians for now. Maybe it is hoped that the interest on Greec debt will be below 5% in 3 years time. One of the scenarios I saw was that all 300 Billion Euros of Greec debt should be covered by a loan from the other EU nations in the next decade, and that it would take at least a decade to get out of this mess.

    There has been talk about several other issues as well:

    1.- The percentage of the Greec economy not taxed is 25% This is a staggering amount. the lost tax revenue is 30 Billion. In Dutch media there was/is talk that Greece officials claimed they could tax a part of that 1.7 Billion in tax revenue. And that they wanted to include those extra tax revenues in the bailout plan, but were not allowed to.

    2.- Some Dutch parties talk in overhauling the Greec tax authorities by sending in for example Dutch and German tax specialists. This in an effort to catch that illusive 30 Billion.

    3.- In German media, such as “die Welt” and “der Spiegel” I have read commentators arguing for a Euro wide development bank, such as is common within some nations. such a bank invests in businesses in the weaker regions paid for by the stronger regions. To help convergence of the overall economy. And thus the strengthening of all.

    Given these 3 points, my question in your analysis is twofold.

    1. Could finding a portion of the tax evasion help in making Greece solvent? And how much would this help. And would this be more likely to succeed with outside exerts and supervision?

    2. Is a Euro wide development bank, or a purality of smaller development banks (to prevent to big to fail) a good idea to get convergence back in the Euro economy?

    Kind regards,


    • Hi Johan
      If I address your questions then
      1. Yes taxing the black economy would certainly help but I feel that it would take time (these people are skilled at avoiding tax presumeably) and that no country ever completely eliminates a black economy. For Greece it seems that the cultural change required will be quite large. So I too would not have put estimates for this in the official bailout/austerity figures.

      2.What you are asking for is a type of regional policy. In general regional policy usually fails in its objectives. There are a lot of reasons for this but two main ones is that the scale of aid required is rarely available/provided and the policy becomes bureacratic and inflexible. If you were really committed to such a plan you would not only need a regional type policy but also a reform plan for the economies involved otherwise the regional policy becomes open ended….I would start the reform first as Europe already has provided plenty of what are de facto regional policies and look where we are!

  11. We should thank the speculators! A steady decline in the euro parity with the dollar ( towards 1.20 for example) will be of enormous help in relaunching growth across the eurozone, which as you rightly say, is essential if the weaker members are to get out of the debt trap. We can already see the benefits for the stronger countries like Germany. As I understand it, it also helps the US fund its debt.

    Secondly, some moderate inflation in the eurozone ( say between 3 to 4%) will help deal with the mountain of public debt – the rise in the cost of imported raw materials could help achieve this. It is vital to keep the cost of imported oil high to encourage a rapid move to alternative and more efficient energy supplies.

    Last but not least, the shock of recent events offers a real political opportunity to Greece to introduce reforms delayed for twenty years of more – which in many ways has become a “stuck” society rather like Yeltsin’s Russia in recent times.

    So why all the gloom and doom? Of course events are messy, but things are going rather well underneath all the surface froth.

    Kind regards


  12. plato wrote:
    “where the law is subject to some other authority and has none of its own the collapse of the state, in my view, is not far off; but if law is the master of government and the government is its slave, then the situation is full of promise and men enjoy all the blessings that the gods shower on a state”
    As you note there is a loss of credibility, when laws are distorted or ignored, we cannot function without rules that are adhered to.

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