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    Where does Greece head to?

    Fatih Özatay, PhD19 May 2011 - Okunma Sayısı: 863

     

    If you are faced with high public debt, you have to take the most radical steps immediately.

    Ten days ago Greece's credit rating was cut by 2 levels to B. At the same day, interest on Greece's 10-year bonds reached 15.6 percent compared to 3.1 percent interest rate of Germany's bonds. Everyone knows the cause of this difference: High level of public debt accumulated upon decades of ill fiscal policy experience and the efforts to mask this via several statistical tricks. There are a number of lessons to be learned from Greece's situation. Firsts is that, you should not manipulate the statistics as the curse of the figures eventually takes effect.

    For the second lesson, you have to dig in the "debt dynamics" phenomenon. If we were to analyze the course of the ratio of public debt to national income for Turkey, which uses the national currency and has the chance to shape the monetary policy independently, the results of the analysis would be as follows: 

    Inflationary effect

    First, debt stock declines as the difference between the interest rate at the time when the borrowing took place and the inflation rate at the time when the payment will be made decreases. In other words, the debt stock will be reduced as inflation grows. Greece does not have this option as the control of the monetary policy is not at their hand. This is fortunate, though, as it would be a dead end. It would not only escalate the cost of borrowing causing a hike in the debt stock in domestic and foreign exchange (FX) terms but also depreciate the currency (that is, increase the exchange rate) causing a hike in the debt stock in FX terms.

    Second, if you can increase the growth rate, you can cause a reduction in the debt stock as a ratio to the national income. However, this cannot be done upon good will and intentions. Some elements should step in to trigger the growth: to begin with, you have to convince people that you have come to senses and initiated a sound economic policy. This will reduce the interest rate. Moreover, people will increase spending as they will be more confident about the future of the economy. If the growth rate relies mainly on exports and tourism revenues, a slight depreciation of the domestic currency can work in your advantage. However, the depreciation should not stem from the growing risks. Otherwise, the rise in the exchange rate will also cause an increase in the interest rate possibly leading to a negative effect on growth. Besides, Greece does not have such an option, so I will skip this one.

    Third, the opposite way round, appreciation of the currency reduces the debt stock in FX terms. The way to ensure the appreciation of the domestic currency is improving the confidence about the economic policy in effect. But evidently, a more valuable currency has negative impacts on exports and thus on the growth performance. Therefore, you will end with two elements that affect the debt stock in the opposite directions. So, this either is not an option for Greece. 

    The way out of the crisis

    Fourth, you can tighten the fiscal policy further. This way, you give the message that you are serious and determined which will reduce the interest on the new borrowing substantially activating the positive effects I referred to under the second option. In addition, you can have the chance to borrow from international organizations on terms more advantageous than the market terms.

    Turkey overcame the 2001 crisis mainly following the fourth option. This path was also present for Greece. Of course, it would have suffered more as it does not have monetary policy independence and success would have been more difficult; but there was this chance anyway. Nevertheless, European Union countries under the leadership of Germany somehow failed to take action immediately. In the end, they decided to lend Greece at a barrenly high interest and short maturity. After some time, they enhanced the terms. But this waste of time did not increase but decrease the markets' confidence in Greece's economy.

    Therefore, the second lesson to be learned should be the following: If you are faced with high public debt, you have to take the most radical steps (extremely tight monetary policy or borrowing from international organizations) immediately. But if you cannot...

     

    This commentary was published in Radikal daily on 19.05.2011

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