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Jan 6, 2010 | 13:14 GMT

5 mins read

Greece: The Closing Window of Opportunity

European finance officials will visit Greece on Jan. 6 to discuss Athens' stated intention to reduce its mounting budget deficit. Greece has not yet put forth a plan to significantly reduce its deficit, and its time (and options) is running out. Germany, meanwhile, is pressuring Greece to get its economic house in order without assistance from the International Monetary Fund (IMF), as an IMF loan to a eurozone country could damage the bloc's reputation.
European finance officials are traveling to Athens on Jan. 6 to discuss Greece's stated intention to reduce its spiraling budget deficit. Greek officials said Jan. 4 they would submit their plan to significantly reduce the budget deficit toward the end of January, not in early January as expected. Greece's current level of resolve to consolidate its public finances has impressed neither the European Union nor the financial markets and has stoked fears of a sovereign debt crisis in Greece. Collapsing government revenues, soaring welfare spending and snowballing interest payments have pushed Greece's budget deficit to 12.7 percent of gross domestic product (GDP) in 2009 — the highest in the European Union and larger than the EU deficit ceiling by a factor of four. Greece is also the second-most highly indebted EU member relative to its GDP after Italy; its gross public debt is currently estimated to be 113 percent of GDP, while the European Commission (EC) had forecast in October that it could be as high as 134 percent by the end of 2011. Currently, however, the ability of all eurozone governments to finance their deficits is being supported by the extremely accommodative monetary policy the European Central Bank (ECB) has implemented to combat the ongoing financial crisis. Athens would like the ECB to maintain low interest rates and generous liquidity provisions because, by enabling banks to purchase large amounts of government debt, it is helping to keep its budget financing costs down. But the ECB conducts monetary policy for the entire eurozone, and its policies are based on its primary directive of targeting low inflation, not on individual member state's needs. This means that Athens has a narrowing window of time to reconcile its budget before the eurozone's monetary needs diverge with those of Greece, making its budget financing more difficult and expensive. Greece has limited options to resolve its debt crisis. First, it could hope to continue benefiting from the ECB's loose monetary policy. However, as ECB President Jean-Claude Trichet has reiterated throughout the financial crisis, the ECB's primary mandate is price stability, which means the liquidity currently helping to support government bond prices cannot remain in the system indefinitely. Furthermore, if and when the economic recovery gains traction, government debt will no longer be the dominant option for investment. As more enticing investment opportunities present themselves, investors' demand for government debt could fall, thus driving up the interest governments need to pay to entice investors to buy their bonds. The bottom line is Athens cannot count on an accommodative monetary policy for much longer. Athens' second option is to ask the International Monetary Fund (IMF) for a bailout package, but Athens is not particularly keen to do so. Any IMF assistance package would require painful and unpopular austerity measures, which could only result in more unrest and aggravate Greece's already tenuous security situation. This option is also unpopular with the eurozone, namely Germany, since it could harm its carefully cultivated image of stability. Germany has therefore pressured Greece with legal arguments and moral suasion to not seek IMF assistance. Germany's resistance to the IMF intervention stems from the desire to preserve its symbiotic economic relationship with other eurozone states. Eurozone members benefit from the perceived lowering of risk to their economies since they receive the benefits of the German economy. As the euro has Germany's full economic weight behind it, eurozone membership generally reduces other members' risk premiums (except perhaps Germany's) and spreads lower interest rates, stimulating spending and economic activity. Since Germany's exports are largely destined for the eurozone, Berlin has a vested interest in supporting credit availability in eurozone states, which it influences by essentially controlling the eurozone's monetary and fiscal policy. It is a win-win scenario in which Germany gets reliable export markets that cannot use their currency to undercut Germany's exports, while Germany's neighbors benefit from lowered interest rates and ample credit. But the eurozone's stability is partly due to the assumption that the German economy implicitly backs all of the eurozone, and thus no member state would be allowed to "fail." Therefore, if Athens were to go to the IMF and be bailed out by a supranational organization most closely associated with the United States, it would imply that Germany is unwilling — or worse, unable — to bail out Greece or other eurozone members experiencing similar fiscal troubles. This explains a Dec. 28 statement from Axel Weber, president of Germany's central bank, that "we [the Bundesbank] don't need the IMF." Though an IMF austerity plan of social program cuts is exactly the sort of policy Berlin wants Greece to implement, it nonetheless would undermine both the eurozone's coherence and the idea that the eurozone takes care of its own. Germany was more than happy to let IMF bailouts take place in Central Europe, since the countries aided were not members of the eurozone and therefore had no impact on the bloc's credibility. However, from Germany's perspective, an IMF bailout of a eurozone country would resurrect the doubts that plagued the euro in its early years. Additionally, if Greece were to seek IMF assistance, the costs of credit financing in peripheral eurozone countries would likely increase, further putting the financial stability of the eurozone — and thus of Berlin's export markets — into question. Therefore, Germany is adamant that Greece implement austerity measures without the help of the IMF and quickly, before the ECB is forced to tighten monetary policy. Berlin will use the Jan. 6 meeting with ECB and EC officials to crack the whip on Athens to shape up and get its financial house in order — on its own — before the EU and eurozone finance ministers' Feb. 15-16 meeting in Brussels.

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