Greece Wrestles with Itself

The change in the Greek negotiating team appears to have helped reinvigorate the talks with the official creditors.  However, insufficient progress has been made that would allow a resumption of aid payments.   Aid has been cut off since the middle of last year, six months before Syriza's election.  

The official creditors have three demands for conditions for resuming assistance.  The Greek government's proposals must be 1) fiscally sustainable, 2) facilitate financial sector stability, and 3) not undermine competitiveness.  

The first two conditions are not problematic.  The political paralysis has weakened the economy and what was once projected to be a primary budget surplus this year is looking like a deficit.  Nevertheless, the government seems willing to commit to a primary surplus of around half of the previous agreement of 3%.  The Syriza government also recognizes the importance of a stronger banking sector.  

The rub is the third condition:  competitiveness.   The official creditors appear to think about competitiveness in terms of labor costs.  This is wages and benefits, including pensions.  The Syriza government is resisting such pressure.  It argues that austerity in those areas weaken the economy, as well as creating more social dislocation (what it calls a humanitarian crisis).  The IMF has previously indicated that it under-estimated the fiscal multiplier--or how mush austerity impacts the economy but seems reluctant to correct its error. 

It is in this context that yesterday's parliamentary action needs to be understood.  Parliament approved the government proposals that in effect reverse earlier public administration reform.  Greece's parliament approved plans to re-hire 13,000 civil servants.  It also eliminated the annual evaluations and merit-based promotions.  

The re-hiring plans include the municipal policy force that had been disbanded about a year and a half ago.  There are also "several thousand" caretakers at state schools that will be re-hired.   Some 600 cleaning women in Varoufakis' finance ministry will also be re-hired, as early as next month, according to reports. 

While the re-hiring signals the rejection of the past agreements with the official creditors, the scrapping of annual evaluations and merit-based promotions pokes a finger in their eyes.  Nor was there a clear indication on how the salaries of the re-hired workers would be funded.  

When queried about the government's plans, Interior Minister Voutsis said, "We aren't going to consult the institutions [official creditors], we don't have to, we're a sovereign state, " according to press reports.    Therein lies the heart of the matter.  Being in a monetary union, or even the EU itself, requires some surrendering of sovereignty.  This is what European officials mean when they say Greece is a member of a select club, and there are certain rules that membership entails.  

Greece wants its cake and eat it too.  It wants maximum sovereignty and membership in the exclusive club.   The rules are not cast in stones, but they are not infinitely flexible either.    The new twist to the plot in recent days has been the "discovery" of a rift between the IMF and the EU.  The IMF seems more concerned with pension and labor market reforms.  The EU is thought to be concerned with the commitment to have a primary budget surplus. 

Many read the IMF's comments as adding pressure on Greece.  We demur.  The IMF added pressure to the official creditors in Europe.  Because the EU has failed to stabilize Greece's debt-to-GDP ratio, the IMF, which had over-lent to Greece in the first place, over-riding its own rules, is reluctant to participate in giving Greece more money.  The IMF's participation in the European  aid packages was controversial in the beginning.  However, ultimately, the IMF's money, credibility, and technical skills carried the day.  

Greece has large euro payment (700 mln) to the IMF due later this month.  As we have noted before missing, the payment would put it into arrears.  It would trigger standing operating procedures for such cases  In 2000, there were 27 countries that were in arrears to the IMF.  By 2011, it had fallen to three.  

The IMF would suspend future payments to Greece until its account was brought back into good standing.  Yet if the IMF were already not going to participate in new funds for Greece, the Syriza government would not be losing much.  That said, falling into arrears to the IMF could spook other investors. 

We still think that the cost of keeping Greece in EMU, as large as that might be, is still less than the cost of forcing it out.  We expect a deal will eventually be worked out.  The end of June seems like the hard deadline, but if an agreement is not reached by early June, it is hard to see how it can be implemented (included acceptance by numerous parliaments) by the end of that month.