Commentary | 04 June 2015

It's time for Greece to take charge of its own financial crisis

It's time for Greece to take charge of its own financial crisis

Stephen Grenville

The Australian Financial Review

4 June 2015

Click here for the online text.

  • Stephen Grenville

It's time for Greece to take charge of its own financial crisis

Stephen Grenville

The Australian Financial Review

4 June 2015

Click here for the online text.

  • Stephen Grenville

Executive Summary

Every week seems to bring a new crisis in Greece. Another debt repayment looms, the Treasury cupboard is bare and then somehow Greece scrapes together the necessary funds from some hidden jam jar.

This week €300 million ($430 million) is due with a further €1.2 billion later in the month, but the International Monetary Fund has already given a grace period until the end of the month.

Time is being frittered away, with nothing resolved. Peripheral Greece is a serial "bad news" story in the financial pages, to the detriment of European growth.

Four months ago, the new Finance Minister Yanis Varoufakis brought a flamboyant flair to the negotiating table. The motorbike-riding, tieless former academic was an expert in game theory - the science of bargaining.

As well, the fundamentals were broadly favourable for a settlement, because the parties on both sides of the table shared a common understanding of three fundamental factors:

●First, all the negotiating parties wanted Greece to stay in the euro. More than that, they all realised that Grexit would be accompanied by bitter recriminations. None wanted to be lumbered with the blame. The IMF and the European Central Bank were particularly conscious of this aspect. They understood that exit would be an intensely political event, and they were not elected politicians. Within their own spheres of responsibility, they would not precipitate an exit.

●Second, there was wide acceptance that Greece cannot pay back its foreign debt in full. At the same time, the creditors cannot write it off or even reduce the principal through haircuts, for powerful political reasons. These apparently conflicting negotiating positions could be reconciled by pushing the debt repayment further into the future and lowering the interest payments. This had already been done in 2010 and in 2012. More rescheduling would be needed, but creditors understood their debts were worth much less than the nominal value. This was a bankruptcy case, not a debt-collection exercise.

●Third, the domestic reform programme was too tough. Greece has made major progress on the budget deficit, but at huge cost. The conditionality had to be eased, while still keeping Greece's "feet to the fire".

At that time, it was understood that the bargaining process would inevitably involve elements of the game of chicken: whichever party was prepared to take the negotiations closest to failure would get the best terms, although at the risk of precipitating an exit and getting the blame.

The broad logic of the solution, however, was fairly clear. Debt repayments would be pushed further into the future (but without a haircut). The budget conditionality would endorse what Greece had already achieved and not ask for greater austerity. Greece would stay in the euro.

So what has gone wrong?

The political and diplomatic process that could turn these factors into a settlement has not happened.

Varoufakis wasted time trying to get a debt haircut, while not putting forward specific proposals for lighter budget conditionality.

The Greek Prime Minister has not demonstrated that essential political skill - how to break your election promises gracefully.

Grexit might not look as disastrous now as it appeared in 2010, but it would be extraordinarily messy. None of the negotiators want to go there. This has allowed the negotiating process to be drawn out.

The problem, however, is that no one knows how to make substantive progress, let alone bring this to resolution.

As this process plays out, the creditors face a collective-action problem. No single one of them is prepared to take decisive action (who is brave enough to declare Greece in default?). None of them has yet devised a strategy which will leave them blameless after Grexit.

The danger now is that there will be an accidental exit (perhaps set off by a run on the Greek banks), with Greece unprepared. Greece has had its opportunity to play "chicken".

Now it is time for it, as the only party without a collective-action problem, to take control of the impasse, agreeing they don't need a haircut on the debt, but they do need further rescheduling.

At the same time they could propose a specific budget plan based on the idea of maximising medium-term growth, which would be in the interests of the Greek people and the foreign creditors as well.

For their part, the Europeans should signal clearly they are ready to agree to this because they have no viable negotiating strategy which can get this Greek tragedy off the financial pages.

 

Stephen Grenville is a former deputy governor of the Reserve Bank of Australia and a non-resident Visiting Fellow at the Lowy Institute.