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Inevitable Greek Debt Relief

 5 min read / 

Despite Greece’s economy accounting for 0.38% of the global economy in GDP terms, it has made financial and economic headlines for months as Alexis Tsipras and his governing Syrzia party attempt to navigate through the consequences of their large debt-GDP ratio.

This ratio has increased since harsh German-led austerity terms have been imposed on Greece, resulting in a 30% decline in GDP, and is likely to increase in the near future as a further austerity programme has been passed through Greek parliament. The ‘humiliating’ conditionality, which will unlock €86bn of bailout funds from the country’s creditors, calls for pension cuts and tax increases – conditions that go against conventional textbook theory in times of depression and the opinion of most leading economists. Paul Krugman, Nobel Laureate and NY Times columnist, is of the opinion that

“Given Greece’s starting point, with debt at 170 percent of GDP, the adverse effects of austerity mean that trying to raise the primary surplus by 1 point quickly causes the debt-GDP ratio to rise by 5 points”

which means that it could take 5 years to end up with the same ratio we would have had with no austerity. Simon-Wren Lewis, University of Oxford economist, claims that ‘austerity is an integral part of the Greek tragedy’. This follows the view that the neoliberal impositions of Germany will kill any impetus to growth.

Despite this, Germany’s Angela Merkel and her finance minister Wolfgang Schauble, have been reluctant to succumb to Greek demands, playing their hand on the fact that Grexit – the term used to describe a Greek exit from the Eurozone – could spell disaster for the Greek economy. It has also been argued that the experiences of Britain and Ireland in rebounding their economies post financial crisis prove that austerity works. The reality is, however, that Greece has imposed more austerity than other governments and we have yet to see any improvement in the economy (see chart).


In the UK, where debt levels were considerably smaller than Greece’s current levels, all that austerity did was delay recovery by two years. Moreover, Greece is in a monetary union, so it is is not able to adjust it’s competitiveness to deal with weakening growth.

The only viable option to solve the Greece crisis without forcing the Greeks into another 5 years of misery, risking another ‘lost generation’ problem, is debt relief. A recent report by the IMF has shown that significant debt relief is necessary. Mario Draghi, head of the European Central Bank (ECB) has also joined the call for debt relief. This is a point backed by Alberto Gallo, Head of Macro Credit Research at RBS, who warned that the terms of Greece’s deal with its European creditors already appeared unsustainable.

“Without debt relief, Greece will not be able to repay its debt…Reforms are positive, but they will take a long time to work through — and the economic, and political, situation in Greece will probably become untenable without a serious consideration of debt relief.”

However, there is some upshot to finally having reached a Greek bailout, with investors reacting positively to the news. This has lowered borrowing costs for the Greek government as prices for Greece’s 2019 bond rose to 64 cents in the euro, up from just 45 cents in the euro last week as the risk of Grexit has diminished. The risk of contagion from Grexit has also declined so other periphery countries, such as Spain and Italy, are also seeing a lowering of their bond yields. This is bringing interest rate spreads in the Euro-area closer together and markets soon may no longer consider Greece a ‘special case’. We are also seeing equities improving in Europe, as the pan-European FTSE Eurofirst 300 is up 1.4 per cent as of July 16th, the highest point this month, suggesting some improved confidence in the economy. With the ECB also accepting a request to provide an extra €900m to the Greek banking sector and a Eurozone backed €7bn bridge loan to prop up the financial sector, Greece may be inching back to relative normality in financial markets.

Nevertheless, this ‘inching along’ is hardly sufficient to solve the woes of Greece and lead to a genuine improvement in the economy. A debt restructuring is necessary and growing ever more likely for two main reasons. First, Angela Merkel is facing increasing criticism for her handling of the Greek crisis. Habermas, widely considered one of the most influential contemporary European intellectuals, claims that:

“forcing the Greek government to agree to an economically questionable, predominantly symbolic privatisation fund cannot be understood as anything other an act of punishment against a leftwing government”

Second, we are seeing the backing of a debt haircut from major European players. Debt relief is necessary, without it austerity will only lead to a permanent failure of the Greek economy.

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