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May 2, 2010 | 16:08 GMT

7 mins read

Greece: Austerity Measures and the Path Ahead

DIMITAR DILKOFF/AFP/Getty Images
Summary
Athens agreed to severe new austerity measures May 2 to secure emergency assistance from the International Monetary Fund and European Union and thus avoid a default. While other eurozone nations are trying to portray the aid as necessary for stability of the eurozone, and not Greece specifically, domestic constituencies, particularly in Germany, are opposed to the bailout plan. The Greek public will also find much to dislike in the plan, and the proposed budget cuts could spark severe domestic unrest the likes of which has toppled Greek governments in the past.
The Greek government has agreed to new austerity measures set by the International Monetary Fund (IMF) and European Union to cut its budget deficit from 13.6 percent in 2009 to below 3 percent by 2014. Greek Finance Minister George Papaconstantinou said the measures agreed upon May 2 will cut the deficit by 11 percentage points of gross domestic product (GDP) for the next three years, amounting to 30 billion euros ($40 billion). The Greek agreement with the IMF and the European Union has received approval from EU Commission President Jose Manuel Barroso, who called it a "credible package." The decision is now in the hands of eurozone finance ministers, who will meet on May 2 to make the final decision on releasing the estimated 120 billion euro ($159 billion) financial aid package for Greece. This is the third time since January that Greece has laid out a plan to cut its budget deficit. On Jan. 14, the government's plan mostly counted on increasing revenue by 4 billion euros from the sale of unspecified government assets, improving tax collection and getting through 2010 with only a 0.3 decline in GDP. The March 3 plan, in the midst of a heightening crisis and talk of a potential bailout, had far more painful measures, such as tax increases on fuel, cigarettes and alcohol and 30 percent cuts in the two months of bonus pay allotted to each civil servant annually. The third budget austerity plan, announced on May 2, includes the following:
  • Public wages and all pensions would be completely frozen over the next three years.
  • The value-added tax on fuel, tobacco and alcohol will rise by 10 percent.
  • An increase in the value-added tax from 21 percent to 23 percent for all goods.
  • A new, unspecified tax on businesses.
  • Taxes on illegal construction, which is common in Greece
  • An increase in the public sector retirement age for women, from 60 to 65, bringing it in line with the retirement age for men.
  • The government would have fewer restrictions on laying off public sector employees.
  • Caps on the two months of "holiday bonus" salaries for public sector employees, and eliminating holiday bonuses altogether for higher public sector earners.
  • Pensioners would no longer be eligible for the two months of holiday bonus pay.

The Next Steps

Germany: Now that Greece has agreed to further austerity cuts, Germany is likely to approve the bailout package, which will require Berlin to forward around 8.5 billion euros in 2010, and possibly as much as 25 billion euros over three years. Public debate in Germany has already shifted from calling the financial aid a "bailout of Greece" to one that "protects the stability of the eurozone" — a clear shift in tone that is intended to raise public support for the plan — and Germany's parliament will likely vote on May 10 to release the funds via the German government-owned development bank KfW. (click here to enlarge image) The first thing to watch for in Germany is whether Berlin forces private sector banks to join it in the bailout, which would put further stresses on Germany's already troubled banks, but would make the Greek bailout far more acceptable to the German public — a recent poll indicated that private bank involvement in the Greek bailout would bring public acceptance of the package to higher than 50 percent. The second factor to watch is the May 9 North Rhine-Westphalia state election, in which voters may punish German Chancellor Angela Merkel's coalition for helping Greece and may take away her control of the Bundesrat — the German parliament's upper house. Eurozone: With Germany now likely to support the bailout package, the eurozone as a whole is likely to approve it as well. Fiscally conservative states such as the Netherlands and Austria have voiced concerns in the past, but will not want to oppose the bailout on their own. The final number agreed upon for aid — likely to be 120 billion euros — will be critical to watch, and whether Germany and other states define plans for what to do with Athens when Greece inevitably misses its deficit reduction targets due to a sharp recession that the austerity measures are bound to provoke. The performance of the eurozone economy over the next three years will also be key — 2010 first quarter GDP flash estimates comes out on May 12, and a steady improvement in economic growth reduces the systemic risks posed by Greece and therefore increases the likelihood that the eurozone will eventually halt aid to Athens. Greece: The austerity measures will be written up as a specific law and passed by the Greek parliament by May 7. Greek unions are opposed to the budget cuts and plan a four hour walkout on May 4 and a general strike on May 5. Athens will brace for what is likely to be a month — and potentially whole summer — of considerable unrest in a country that has erupted in the past for far less. In December 2008, public anger with the financial crisis, the government's handling of forest fires and the shooting of a young boy by police elicited protests across the country that ultimately brought down the ruling center-right government. Greece has a history of political violence and one of the most bitter left-right political splits in Europe. It also has a considerable violent anarchist tradition. This makes it extremely difficult for the Greek government to effectively implement austerity measures requiring Greece to cut social benefits, improve tax collection and raise consumption taxes — three things that the country has never managed to successfully accomplish individually during times of economic stability, let all alone all three at the same time during a crisis. Protests and strikes could destroy the coming tourist season — a sector which accounts for between 15-20 percent of Greek GDP. This would deepen the Greek recession and reduce government revenue and thus impede budget deficit reduction efforts. Prolonged and severe protests could eventually bring the government down, again plunging Greece and the eurozone into uncertainty. Portugal and Spain: European leaders have defended the financial aid package of Greece to their publics as necessary for the stability of the eurozone. The first indication on whether the bailout was successful in calming markets will therefore be a coming Portuguese bond auction. The coming week will give an indication whether the 120 billion euro financial aid package has sufficiently calmed investor fears and given more time to Spain and Portugal to begin putting their budget finances in order. Also key to watch is whether the uncertainty with sovereign finances migrates to the financial sector of Europe via the weak Spanish and Portuguese banking sectors.

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