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Greece will take a deep breath, but will not be in comfort
The preceding week was quite critical for Greece. The decision European Union will make in the Euro-zone country leaders meeting last week was of vital importance for the country. But, will the resultant rescue plan implied in the delivered statements enable Greece to take deep breath? The short answer is, though it will, the process will not be easy and comfortable. There are some problems related with design. I will try to clarify the issue.
As you might remember, I have talked about Greece's situation at this column as far as I figured out. The problems Greece faced were no harsher than those Turkey encountered during the 2001 crisis. Greece could overcome this crisis just as Turkey overcame the 2001 crisis with the Transition to the Strong Economy Program implemented right after the crisis and secured a more stable economy in 2007. What is more, Greece could enjoy the advantage of being in the Euro-zone.
However, to be successful, they had to advance on the fundamental problem: Greece needed a long -term fiscal discipline program that will ease high budget deficit and public debt. Moreover, they should have convinced everyone that the program is sustainable. So, here was where the fundamental problem rose. First, there were protests against the announced program. Could the government resist to the opposition? Second, in the past both the debt and budget figures were manipulated. Could they play the same game also this time?
Although the government would assure people that no manipulation will be made, a third problem would come out. Borrowing interest rates in Greece increased continuously. This implied a further rise in the high public debt, which in fact is the main source of the emerging problem. What is more this led to a highly unfavorable dynamic. Those believing that the debt is unsustainable demanded higher interest for treasury bills. And as higher interests would increase the debt further in the coming period, sustainability was disturbed more and interest rose further in a vicious circle.
The only chance to break this circle was a foreign credit support with an interest rate lower than the current level. But another important problem was encountered here. If the EU provided support for a country which spent irresponsibly and also tried to hide this, such behavior could have been imitated also by other member countries. So, under these circumstances, the only viable option appeared to be signing a deal with the IMF. As an IMF member country, Greece had the right to ask the support of the Fund. Moreover, IMF support could have solved the problems related with credibility. IMF's expertise and determinedness in these issues would have built confidence across the markets concerning the tightness of the fiscal policy Greece implements. Nonetheless, in that case, EU's common currency zone would have been damaged in terms of long term sustainability of the zone. It would be verified that the EU fails to solve the problems of its own.
Conflicting statements by the EU's important persons and the unfavorable statements by the European Central Bank on the one hand and being unable to pursue the IMF option easily on the other put Greece into a very hard position. But the statements made following the EU leaders meeting reduced the ambiguities partially if not fully:
First, Greece will be provided with mixed support package. Though the amount of credit to be provided is not officially announced (it is estimated to be around €25 billion) more than half of it will be given by the EU at market interest rates and if necessary (if Greece fails to borrow at the market). The rest will be provided by the IMF. Moreover, there was another problem stemming from Greece's low credit rate: but the barriers to short term credit support in exchange for the collaterals to be provided to the European Central Bank were eliminated with the statement Trichet made.
So, will what we learned so far be a remedy for Greece's problems? The most fundamental problem of the plan can be considered as the fact that the support from the EU is not a support at the purest sense since it will step in if necessary and will work at market (high) interest rates. If you make such an important issue conditional, you not only fail to give sufficient guarantee to the markets but also provide them with an 'opportunity' they will seek (test). But if the amount of funds transferred via the IMF is increased and the date of transfer is backdated, this negative possibility can be offset. Moreover, IMF provides credits at terms more advantageous than market rates. We will see.
This commentary was published in Radikal daily on 29.03.2010