Bailout programme an albatross around Greece\\\'s neck

Greece is now facing an unprecedented economic crisis. A protracted debt crisis, which began in 2010, has now become a full-blown macroeconomic crisis. Its gross external debt relative to GDP (gross domestic product) as of 2015 1st Quarter has reached an unsustainable 243 per cent. In the last five years, Greece availed two bailouts worth more than EUR245bn from its international creditors. The country is presently negotiating its third bailout. Germany, France and IMF (International Monetary Fund) are its major creditors. A trilateral framework comprised of the European Commission, the European central Bank (ECB) and the IMF is representing the Greece's creditors. Greece is a member of European Monetary Union. The country has therefore qualified bailouts under European Stability Mechanism (ESM).
Both the bailouts involved persistent budget cuts, a freeze in wages and pension benefits, and tax increases. To put them in specific terms, the bailout conditions required a fiscal consolidation in order to bring general government deficit down from 13.6 per cent of GDP in 2009 to less than 3.0 per cent by 2014. Pensions and wages were to be reduced and frozen for three years. An improved VAT system was supposed to add 4.0 per cent of GDP through 2013. Greek government would strengthen its revenue administration and pursue a range of expenditure controls so that the country could achieve an incremental gain of 1.8 per cent of GDP. Government would curtail entitlement programmes and so social safety nets would have to be rolled back with a few exceptions. The proposed structural reforms included modernisation of public administration, strengthening of labour markets and income policies, improving business environment and divestment of state-owned enterprises. Finally, military spending would undergo a substantial reduction.
Eurogroup and IMF argued that observance with the bailout conditions would resolve Greece's fiscal and debt problems. Along with deep structural reforms, the planned austerity would strengthen Greece's international competitiveness and spur economic growth. The policy mix of austerity, however, proved counterproductive. It led to a sustained economic contraction in Greece. Its investment-GDP ratio slumped. Industrial production greatly suffered. Unemployment rate soared from less than 10 per cent in 2010 to 27 per cent in 2014. Greece's GDP has contracted by one-third of its pre-crisis level.
The austerity measures also failed to bring about the much needed price competitiveness.  Changes in real exchange rate from 2001 to 2009 indicate how Greece let its export production down. Real effective exchange rate (REER), a measure of relative price of Greece's home goods in terms of foreign goods, in fact observed a sustained appreciation by more than 30 per cent in this time. This happened as the surging capital flow continued to shift Greek aggregate demand to the right and the domestic price kept rising. As an outcome, Greek exports lost their price competitiveness in the rest of the world and its current account deficits widened. A false signal in recent movements of REER deserves further explanation. It is that austerity measures led to serial contraction of Greek economy after 2010 and accompanied a moderate real devaluation via falling wages and other prices. Export-GDP ratio, though increased in this time, it was no recovery. This must not be a ground for further austerity because at the same time both GDP and investment-GDP ratio declined precipitously.

Two consecutive bailouts in combination with a range of fiscal contractionary measures did not help Greece's ballooning debt-GDP ratio. The ratio increased from 180 per cent in 2010 to 245 per cent in 2015. Worse is that only debt structure of the country has changed. Indebtedness of the Greek general government and Bank of Greece has increased while that of deposit-taking corporations declined. A large part of the bailout funds has thus either vaporised or gone for rescuing the private sector creditors. Greece once again failed to honour its debt repayment, scheduled on June 30, 2015, to the International Monetary Fund (IMF). Facing an imminent collapse of its financial system, Greece's leftist government led by Alexi Tsipras wrote to ESM for third bailout. Greece's creditors this time proposed harsher conditions. Tsipras initially rejected the terms, asked for a referendum, and publicly campaigned for a 'No' verdict.

Greek people overwhelmingly approved the 'No' referendum on July 05, 2015. The people thus rejected the punitive conditions that Greece's creditors had demanded. For more than three weeks, Greece's banking system was de facto shutdown and capital controls were in place. ATMs rationed very limited cash balances to its citizen. The entire economy stalled as transaction system collapsed. Greece's PM Tsipras had no option but to submit to the creditors' demands. A new deal was, in principle, reached between Greece and its creditors on July 12. The deal is unfortunately the same what Greek people rejected on July 05.
The new deal called for a successful conclusion of a Memorandum of Understanding (MoU) between Greece and its creditors. In order to form the basis for this MoU, the Greek authorities shall carry out a number of actions. Firstly, the government must scale up a privatisation programme. Valuable Greek assets will be transferred to an independent fund that will monetise the assets through privatisation and other means. The monetisation of the assets will largely be a source for repayment towards the new ESM bailout loan. Privatisation is further expected to generate another EUR 50bn. Of this, EUR 25bn will be used for bank recapitalisation, 50 per cent of the remaining balance will be used for reducing Greece debt-GDP ratio and the rest shall be available for investment. This fund will be created under a legislative framework and will be under the supervision of Greece's creditors. It is ironic that the fire sale of Greek lucrative assets would not be used for improving Greek's depressed investment-GDP ratio.
Secondly, Greek government would carry out an ambitious plan for further fiscal consolidation in some two weeks. It included the streamlining of the VAT system and the broadening of the tax base. Government should take upfront measures to improve long-term sustainability of the pension system. That essentially means that Greek government should reduce pension payouts in order to achieve a zero-deficit clause by October 2015. Thirdly, on energy markets, the government should proceed with privatisation of the electricity transmission network operator (ADMIE). In the labour market, labour policies must be aligned with international and European best practices and shall essentially include the provision of collective dismissals. Finally, Greek government shall carry out decisive actions on non-performing loans of its financial system and shall improve governance of Hellenic Financial Stability Fund (HFSF).  
Unfortunately for Greece as well as Europe, the very premise of this yet-to-be-defined bailout package is deeply flawed. It would delay a Greek bankruptcy not revitalise the rapidly declining economy. The new Greece bailout programme will only affect Greece's debt structure not its debt sustainability. It is largely designed to bail out Eurozone's private creditors only to be offset by a rising public debt of Greece. It will very likely aggravate an already alarming and protracted economic downturn, compounding poverty and exceptionally high unemployment.
Greece within Eurozone is not competitive. To compete, Greece needs a strong devaluation-a substantial decline in its relative prices. To bring in this change via lowering of prices and wages would bankrupt many debtors and cause more problem loans in Greece's financial system. A nominal devaluation, on the other hand, could be a more powerful mechanism of sustainable recovery. That would essentially require Greece to exit from the monetary union. In the short-run, a Grexit will be very painful though. It must be accompanied by debt forgiveness and a provision of humanitarian aid for the purchase of essential imports. Greece's creditors may grant it a moratorium for debts due for repayment over the next five years. A restructuring of Greece's external debt is also imperative.
A Grexit and consequent restoration of Drachma, the name of the old currency, will make Greece's domestic goods cheaper. Greek citizens will then buy their domestic goods more than foreign goods. More importantly, it would reduce relative prices of Greek exportables in the rest of the world. Export production would therefore surge. Tourism would flourish. It would bring about rising private sector investment, more manufacturing employments, and a sustained resolution of Greece's external account imbalances. A new currency, and hence a substantial devaluation of it, shall invite foreign direct investment (FDI) to Greece. Capital flight would reverse. Rich Greeks will bring their laundered money back home. They would start buying real estate and a construction boom would likely follow. Greece can recover to a healthy state in a more plausible time. Greek authorities can fix their institutions and plan to rejoin the monetary union.

Mizanur Rahman, Ph.D. is Associate Professor of Accounting & Public Policy and  Research Director Accounting for Capital Market Development (ACMD), Department of Accounting & Information Systems (AIS), University of Dhaka.
mzr.rahman@gmail.com, mizan@du.ac.bd
Website: http://acmd.com.bd/
Twitter: @mizanur2253