Despite the Greek government’s best efforts, last night’s meeting of euro-area finance ministers failed to approve the release of new funding. We think it’s only a matter of time before Greece gets its money. But the latest delay reflects deep disagreement about how to reduce current unsustainable debt levels. Until the euro area addresses this key issue, caused by the failure of the Greek program, the risk of a disorderly exit from the euro area will remain real.
Myth and Reality
When the first Greek loan facility was agreed in May 2010, the economy was expected to contract by a cumulative 6.6% in 2010 and 2011, but to start growing again this year. In reality, though, the Greek economy contracted by a cumulative 11.7% in 2010 and 2011, and official projections suggest that it will shrink by a further 9.9% in 2012 and 2013.
The irony is that the painful “cure” has made the malady worse. Instead of government debt to GDP peaking at 150% in 2013, the government’s latest projections suggest that it will top out at a staggering 192% of GDP in 2014.
The main culprit has been the collapse in nominal GDP. The original program assumed that this would increase by 4.9% to €242 billion in 2014, whereas the latest estimates suggest that it will fall to €183 billion, nearly 25% lower than envisaged.
This collapse in the denominator has made it impossible for Greece to stabilize its debt-to-GDP ratio, even though the level of debt in nominal terms is expected to be lower than assumed in the original program: €350 billion in 2014 compared with €359 billion. The results of this miscalculation are obvious in the chart below, which compares the baseline debt trajectory expected following the second Greek program with recent projections from the 2013 budget. The gap between the two projections, made just seven months apart, is enormous.
Against this backdrop, it’s hard to see how Greece will be able to reduce its debt-to-GDP ratio to the original target of 120% by 2020 (favored by the IMF) or 2022 (favored by euro-area finance ministers) without a second restructuring involving official sector write-offs. The problem is that euro-area governments, as the main creditors, are reluctant to agree to such a restructuring for fear of the public backlash that would undoubtedly unleash.
As so often since the beginning of the sovereign-debt crisis, we believe the immediate crisis will be dealt with. But there is still no appetite for tackling the much more fundamental issue of debt sustainability. It’s high time for euro-area governments to admit that the Greek program isn’t working and look for a different approach.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein.