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Debt relief or a fourth financial assistance programme for Greece?

Summary:
The Eurogroup faces a difficult choice on Greece — implementing a debt reduction plan drastic enough to make a return to market borrowing possible, or agreeing to a fourth financial assistance programme and continuing to fund Greece at the preferential lending rate. After long delays and tough negotiations, the Greek parliament has formally adopted the measures needed to conclude the current review of the third financial assistance programme, amid protests on the streets. The Greek government now expects the Eurogroup to come up with debt relief measures. We have been here before. The conclusion of almost every review of the various Greek financial assistance programmes went the same way and left largely unfulfilled expectations for debt relief. Meanwhile, even though almost

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The Eurogroup faces a difficult choice on Greece — implementing a debt reduction plan drastic enough to make a return to market borrowing possible, or agreeing to a fourth financial assistance programme and continuing to fund Greece at the preferential lending rate.

After long delays and tough negotiations, the Greek parliament has formally adopted the measures needed to conclude the current review of the third financial assistance programme, amid protests on the streets. The Greek government now expects the Eurogroup to come up with debt relief measures.

We have been here before. The conclusion of almost every review of the various Greek financial assistance programmes went the same way and left largely unfulfilled expectations for debt relief.

Meanwhile, even though almost two-thirds of the three-year financial assistance programme has passed, the IMF is still hesitating to join this third programme. Beyond various reforms, IMF demands lowered fiscal targets and debt relief – applied only to the European part of the official loans, not its own.

Debt relief measures were promised by European lenders at the inception of the current third financial assistance programme. Those measures were supposed to be specified toward the end of the programme, conditional on Greece implementing the programme conditions.

The programme ends in only about a year from now and Greece is implementing it, so it is time to think about what will come after.

There is certainly promising good news: economic growth in the past two years was much better than expected and growth is set to accelerate in the coming years. Unemployment is decreasing, though painfully slowly. The Greek government’s primary budget surplus well exceeded expectations and reached 3.9% of GDP in 2016. What’s more, since the Greek economy is estimated to perform well below its potential output level, the so-called cyclically-adjusted primary budget surplus reached an astonishing 8.7% of GDP in 2016, according to the European Commission’s May 2017 estimates. While the Commission’s cyclical adjustment methodology has a number of weaknesses (as I argued here), the 8.7% primary surplus estimate is remarkable. It suggests that, after all the negotiations and the pain, Greece has implemented major fiscal adjustments.

So what’s next? While Greek public debt is expected to fall, it remains very high. The European Commission’s most recent projection foresees a decline from 179.0% of GDP in 2016 to 174.6% in 2018. Even if Greece maintains an overall budget balance, new borrowing will be needed, because a large amount of debt will mature in the coming years which will have to be repaid (see here). Given the high level of debt, the dominant share of official creditors in Greek debt and all the uncertainties that characterise the Greek economy and politics, it is unreasonable to assume that Greece will be able to return to market borrowing at an affordable rate in the foreseeable future.

This leaves bitter choices for the Eurogroup: implement a debt reduction plan drastic enough to make a return to market borrowing possible, or to agree to a fourth financial assistance programme and continue to fund Greece at a preferential lending rate. None of the options is attractive to euro-area lenders.

Greece has suffered a dramatic economic and social collapse since 2008 and all Greek governments have bowed to the decisions of the Eurogroup. It is now time to fulfill the promise of debt relief and thereby offer more hope for the future.

Zsolt Darvas
Zsolt Darvas joined Bruegel as a Visiting Fellow in September 2008 and continued his work at Bruegel as a Research Fellow from January 2009, before being appointed Senior Fellow from September 2013. He is also a Research Fellow at the Institute of Economics of the Hungarian Academy of Sciences and Associate Professor at the Corvinus University of Budapest.

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