Breaking the Greek Debt Impasse

In order to reconcile Greek and German positions over Athens’ oversized public debt, leaders should urgently develop a concept that aligns some of Greece’s requests with the preservation of existing rules and with the principle of equal treatment for all eurozone member states. They could start by adopting a target for the reduction of total public debt for the eurozone as a whole rather than for each individual country.

The Political Hurdles for Tsipras

An extraordinary meeting of the Eurogroup, the council of the eurozone finance ministers, will take place in the next few days with the objective of breaking the current deadlock over Greek debt. With the positions of the Greek and German governments seemingly irreconcilable, the current episode may prove to be one of the most contentious negotiations in the history of the European crisis.

Germany is not alone in taking a tough line with the new government in Athens. Under severe pressure from their own brand of euro-critical fringe parties, European governments are showing a strong reluctance to embrace Prime Minister Alexis Tsipras’ requests for a substantive revision of the European debt agreements. The Front National in France, Podemos in Spain, and Alternative für Deutschland in Germany all pose serious threats to the governing coalitions. By rebutting Syriza’s requests and forcing it to accept the European rules, national leaders want to send a clear message to voters that other radical or populist parties have no chance of changing the current European governance framework. In short, national governments are fighting for their own survival in what might be seen as a day of reckoning between pro- and anti-European politics in the EU.

The new government in Greece also finds itself in a political bind, with voters expecting it to deliver on the ambitious promises on which it was elected. The new government badly needs to recover some fiscal space to alleviate the social plight of the Greek population. Tsipras thus needs to reap concessions from European creditors in order to allay the country’s fiscal constraints without jeopardizing the sustainability of the public debt. The problem is that Tsipras has given too little consideration to the consequences for the rest of Europe and, as such, he underestimates the resistance his proposals face among other member states. Rhetoric about the need for Europe to change course cannot be used as a substitute for a common position on how to manage excessive public debts.

An Olive Branch from Athens

Encouragingly, a sense of reality is emerging surprisingly fast in Athens. According to the Greek finance minister, Yanis Varoufakis, Greece is set to drop its demand for a reduction in the face value of loans from Europe,  proposing instead a “menu of debt swaps” including two new types of bonds. The first would index the loans provided by Economic and Monetary Union states to Greek nominal economic growth, while the second, termed “perpetual bonds,” would replace European Central Bank-owned Greek bonds. While the latter is widely considered a non-starter given the legal constraint of the ECB and the prohibition on monetary financing, the first type of bond offers a way to link Athens’ requests with closer control of the Greek political economy by EU partners. Since interest payments to other countries—and consequently the yearly tax revenues estimated in their national budget laws—would depend on the Greek political economy, the partners would have a legitimate say in the Greek government’s choices.

Even the Greek proposals demonstrate the need for cooperation on a range of policy decisions. For example, the key objective of the new administration remains limited to tackling tax evasion and vested interests. These are laudable objectives, but they fall short of the comprehensive effort required for modernizing the Greek economy. A revision of the financial terms with creditors should be accompanied by a greater commitment to restoring Greece’s position in the European economy and securing the future of Greek debt sustainability.

Debt sustainability remains the primary concern of the key actors, both in Athens and in Brussels, most interested in finding a compromise. In this context, Varoufakis has said Greece will propose maintaining a primary budget surplus of 1 to 1.5 percent of GDP, even though this would prevent the new government from making good on their spending promises. This would be a first signal of subordination of national policy discretion to a European obligation. Such a move should be met with encouragement by European negotiators.

The question now is whether Brussels will be able to offer an adequate and innovative platform for an agreement that reduces the Greek debt burden without eroding the credibility of European economic governance.

Finding a Way Forward: A Debt Target for the Eurozone

The European institutions – the EU Commission in particular – should rise to the challenge and provide a solution that takes into account the ethical responsibility of creditor countries in the mistaken policies imposed by the Troika, resulting in a loss of one quarter of Greek economy. They could start by adopting a new target for the total public debt of the eurozone as a whole at 60 percent of total GDP. In this framework, while all countries would be required to converge toward the 60 percent threshold, some would be allowed to have a higher debt provided the area as a whole remains within the 60 percent limit, thus preserving the financial attractiveness of the euro and its stability. The path of convergence of the national debt of countries with public debts exceeding 60 percent of their GDP would still be determined according to the automaticity of the debt-brake rule, as stated in the so-called Fiscal Compact—prescribing a yearly cut of the exceeding debt by one-twentieth. However, the reference value for the exceeding debt would be measured in terms of what is required for the euro area as a whole to reach the 60 percent threshold, rather than individual countries.

Since a few countries—including Germany—are expected to post public debts below 60 percent of GDP after 2020, those countries that still have higher debt would be allowed to converge more gradually. The direct consequence for Greece would be that the fiscal correction required would be smoothed out and the required primary surplus could be met at a more tolerable pace.

According to estimates by the International Monetary Fund, Greece’s general government primary surplus (net lending) in percent of GDP was expected to reach 3 percent in 2015, 4.5 percent in 2016 and remain above 4 percent through 2019. In the longer term, the primary surplus might have to remain above 3 percent in order to reach a debt-to-GDP ratio of 60 percent by 2040. The adjustment program designed by the EU Commission projects Greek debt to be around 90 percent of GDP in 2030 (under a median scenario). Now, if we update the scenario to capture Syriza’s policy proposals—assuming the new government seeks a compromise with the EU institutions—which include cancelling existing privatization plans and reaching a primary surplus around 1 percent lower than hitherto prescribed, then Greek public debt should decline to 110 percent of GDP by 2030 and to around 90 percent by 2040.

For its part, Germany remains determined to stick to a balanced or slightly positive general budget. This would bring German public debt to around 52 to 53 percent of GDP in 2030 and slightly over 30 percent in 2040. Such projections would, if realized, bring the level of total eurozone debt markedly lower. German debt currently amounts to almost one-fourth of the total debt of the eurozone. If the eurozone were to set a target of 60 percent of total area public debt, the halving of German debt would allow other countries substantive leeway. In particular, Greek debt—which amounts to slightly over 3 percent of the total eurozone debt—could easily remain around 90 percent without jeopardizing the stability of the euro, and a Greek primary surplus consistent with a 90 percent target would be compatible with the new government’s agenda. Since Germany, Italy and France represent around 70 percent of total eurozone debt, they should lead the initiative.

A limit of 60 percent for eurozone debt as a whole would:

• allow national policy preferences to remain distinct, unless otherwise desired;
• moderate the steep reduction of public debts prescribed by the fiscal compact that is choking economic growth;
• keep the supply for government securities at a level consistent with the demand by the eurozone banking and financial system;
• maintain differences among each state’s government policies responding to the citizens’ preferences on the adequate level of taxation;

Leaders urgently need to find a solution that aligns some of Greece’s requests with the preservation of existing rules and with the principle of equal treatment for all euro-area member states. A debt target for the eurozone as a whole might just achieve that.