On Sunday, 61.8 per cent of Greeks voted "No" to accepting what they considered a "humiliating" debt bailout proposal offered by the troika, the European Commission (EC), European Central Bank (ECB) and the International Monetary Fund (IMF). Barring an incredible turnaround in the coming months, the stage is set for Greece exiting the euro zone, a first within the currency Union.
This article states the facts, and shows that everything that has occurred till today is like a tragedy set in classical Grecian terms, where the calamity at the end is portended from the beginning. Of why Grentry foretold Grexit.
Read more from our special coverage on "GREECE CRISIS"
The Maastricht Treaty's Stability and Growth Pact (SGP) set the criteria that nations had to meet to be in the euro zone. Though modified, it prescribes limits on inflation, fiscal deficit and public debt to GDP, and interest rate on 10-year government security. Based on the SGP conditions, 11 countries were initially admitted to the euro zone. Greece was desperate to enter and fudged macroeconomic data to make the SGP cut. The EC knew this. But it, too, wanted to prove the euro could work just as well in far-flung Greece as it could in the core. So, it qualified as the twelfth euro zone country in January 2001.
Suddenly, Greece was awash with undreamt inflows of the world's second-most important currency. With the 2004 Summer Olympics in Athens, the party had just begun. Between 2001 and 2007, there was only one year when Greece's GDP grew at a rate less than the euro zone's average; and in many these were much higher. Flushed with never-ending money and investments in infrastructure, real estate and tourism, the Greeks never had it so good.
There were four problems. First, most of the growth was financed by foreign debt, not equity. But neither lenders nor borrowers cared, for the euro was convertible and Greece was growing rapidly. Second, such huge fund flows gave Greek governments the excuse to increase subsidies, pay higher salaries and pensions and create larger public sector employment. In 2003, the government's final consumption expenditure was 18.5 per cent of GDP. By 2007, it was 19.7 per cent, and then grew to 22.7 per cent in 2009 - well out of kilter for an economy of its size.
Third, in not a single year since joining the euro zone in 2001 did Greece meet the fiscal deficit and public debt conditions. Not by a long shot. By 2007, its general government deficit was at 10.5 per cent of GDP and public debt at 103 per cent. To be fair, after the global financial crisis, neither France and Italy nor Spain could meet the SGP targets. But these were "too big to fail". Greece, accounting for two per cent of EU's GDP was not.
Fourth, most Greeks are habitual tax evaders. Rich dodgers prefer Swiss banks; others prefer cash. For years, the government avoided publishing its tax collection data. When forced to do so and scrubbed for uniformity, it showed Greece's direct tax collection at eight per cent of GDP - some 400 basis points below the euro zone average. It has got worse. The government collected less than half of its tax dues in 2012.
These four flaws - mounting international borrowings, an unsustainable public sector, huge fiscal deficits and public debt, and poor tax revenues - came to a head in 2010. By then growth had fallen dramatically; fiscal deficit exceeded 11 per cent of GDP and public debt was at 146 per cent. Greece needed its first bailout.
In May 2010, the troika responded with a euro 110 billion loan to prevent sovereign default and cover Greece's financial needs from May 2010 to June 2013. The package required implementing austerity measures, structural reforms and privatisation. These didn't happen in any significant way. 2012 saw a second bailout of euro 130 billion, including bank recapitalisation of euro 48 billion. Private creditors holding Greek government bonds had to take a haircut of 53.5 per cent. Even that failed. In December 2012, the IMF promised another euro 8.2 billion of loans between January 2015 and March 2016.
Then came the December 2014 elections. Alexis Tsipras' left-wing Syriza won enough seats to form the government. Tsipras promised to end Greek humiliation. With the total debt at euro 323 billion and public debt at 170 per cent of GDP, he went to the wire with demands for more concessions. Rejecting the last troika offer, he forced the referendum.
What now? The EC and the ECB will lose all credibility if the referendum result allows Tsipras to substantially renegotiate its liabilities. Greece has failed not once, but thrice. Not even another massive haircut will work because Greek governments have always reneged on their debt covenants. Brussels must know that generously accommodating Greece for "euro zone unity" will release a genie that can't be dealt with.
There is a cost of euro 323 billion, of which euro 40 billion is held by private banks, another euro 40 billion by IMF and ECB, and the remaining euro 243 billion by euro zone members led by Germany, France, Italy and Spain. The banks will take a minor hit relative to their balance sheets; the IMF and the ECB can swallow euro 40 billion; for the rest, it will involve knocking off sovereign assets. Painful, but not impossible.
For Greece, too, the euro zone is not feasible as of now. It can't play free-rider forever. The conditions under which it can be "saved" are so expensive that the lenders won't be forthcoming. Greece will suffer considerable pain for a couple of years. Banks curtailing cash outflows, strict rationing of credit, no major international fund inflows, huge increase in the interest rates, serious inflation and a great deal of economic chaos and human pain. Yet, if handled by a government more capable than that led by Tsipras, Greece will settle to a new equilibrium. It will remain in the EU but with the drachma. Just as the Czech Republic has its crowns and Poland its zlotys. It is the only sensible way out.
Will this happen? Brussels can be spooked and is known to goof up. So, it's even-steven.
The writer is a noted economist and chairman of CERG Advisory Private Limited
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
