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(Not) a Greek tragedy

Greece wants to stay in the Eurozone and at the same time scale back austerity. But there is limited scope for negotiation.

In ancient tragedies the players are so enmeshed that they find themselves in a hopeless situation. The similarities with Greece are now unmistakable. Today’s players are also enmeshed – through the single currency. The difference is that while their situation is clearly difficult, it is not hopeless.

Negotiations about the reforms Greece must undertake have been anything but easy in the past and that will probably prove difficult in the future. The incoming government in Athens will find itself under pressure to reduce the impact of austerity and reform policies on the population. Meanwhile, the Troika made up of the International Monetary Fund (IMF), the ECB and the EU Commission will exert pressure to ensure that Greece perseveres with such policies.

Possible outcomes

The situation does not have to conclude like an ancient Greek tragedy. Key economic data from peripheral countries such as Greece have improved considerably since 2009. About five years ago, following the onset of the global financial crisis, investors began keeping a very close eye on unwanted economic developments in the Eurozone. Firmly in their sights were countries that imported more goods and services than they exported. Greece, Ireland, Portugal and Spain were suddenly faced with a brand new situation.

Years of improving standards of living from external capital inflows appeared to have given such countries a degree of economic independence. But when these financing sources dried up, a balance-of-payments crisis followed. In addition, foreign lenders called in outstanding loans. Consequently, the state, private households and companies were all forced to trim their expenditure and to save more. Decreasing domestic demand also negatively impacted imports, which in turn contributed to lower current-account deficits.

Competitiveness must also still be improved. In March 2009, the then ECB president Jean-Claude Trichet described the adjustment mechanism as follows1: “In these countries, loss of production and jobs are potent stabilizing factors which will narrow the long-standing gap between the level of domestic savings and investment”. In the past, southern European countries could opt for currency devaluation to salvage competitiveness, but the introduction of the Euro wiped out that option.

Regaining competitiveness – a pre-requisite for a balanced current account – within a currency union is achieved through structural reforms, but this also has a negative impact on the labor market. As such, southern European countries have witnessed falling wages and prices as well as shrinking gross domestic product. To alleviate the social costs of the reform process, the IMF, other Eurozone governments and the European Financial Stability Facility (EFSF) granted aid to these countries.

Desirable euro

Aid meant that Greece did not have to abandon the euro. Surveys indicate that around 80% of the Greek population want to keep the euro. It is clear to both voters and their elected representatives what abandoning the euro would mean: Greece would once again have its own currency, which would immediately depreciate versus foreign currencies. The consequences would include inflation and a drastic reduction in purchasing power.

The incoming Athens government will also know that it is not possible to remain in the Eurozone and simultaneously bring austerity and reform policies to an end. Governments need loans from investors to finance comprehensive spending programs. The capital markets have little appetite for this. Consequently the new government has little option but to increase tax receipts through a more efficient taxation system and to negotiate with the Troika about further reforms in order to achieve further relief on existing loans.

The new Greek government will be fully aware of the lack of alternatives in the current situation. And the Troika will continue to demand reforms while offering financial support to alleviate the social impact.

Contribution of individual economies to the Eurozone's current-account balance

Imbalances removed
Peripheral countries’ current accounts have improved enormously. Wage reductions and solid government budgetary policy have negatively impacted imports and thereby reduced current-account deficits. As a result, it is unlikely that there will be a renewed euro crisis. Germany and the Netherlands also generate large surpluses for the Eurozone's current account.

Greek government debt

High level of government debt
In recent years, the IMF, ECB, Eurozone governments and the EFSF have all granted the Greek government low-interest bailout loans. From the end of 2012 to the end of 2014 such aid totaled €190.9 billion.2 By contrast, domestic Greek investors reduced their sovereign-bond holdings. This is clear evidence that Greece is still dependent on foreign aid.

Eurozone (GDP growth in %)
Structural reforms in peripheral countries will continue to inhibit Eurozone growth during 2015


1.2 % 
(2015 F)


Deutsche AWM forecast as of 11/17/2014


Eurozone 
(benchmark interest rate in percent)
The ECB is likely to keep interest rates very low this year



0.05 % 
(Dec. 2015 F)


Deutsche AWM forecast as of 11/17/2014


ref-1

1 Annual Conference of the Asociación de Mercados Financieros (Association of Spanish Securities Traders) in March 2009

ref-2

2 Source: Citi Research, Barclays, Ekathimerini, Société Générale, ECB, Bank of Greece; as of January 2015

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