Greece Deal Is A Compromise, Not A Solution

The agreement reached by EU leaders is not sufficient to reach the debt targets agreed with IMF. In addition growth assumptions etc. appear optimistic.

Is this cause for alarm? We think not! EU leaders are well aware and are now mentally preparing themselves to take further steps after the German elections.

With few other options left EU leaders will eventually have to accept a debt write-down.

This is the most important message to take home from the Greek aid deal: EU leaders are ready to do more for Greece at a later stage. Greece will not be forced to exit.

Greek deal is a compromise, not a solution
After a third marathon negotiation a deal on Greek debt was finally reached. However, the deal does not seem to be a long-term solution. Even though EU leaders used pretty much all the instruments available but an official sector debt write-down, the agreement appears not to be sufficient to reach the debt targets agreed with IMF (124% of GDP in 2020 and less than 110% of GDP in 2022) according to an article in today’s FT.

In addition, the assumptions that Greece will be able to tighten the budget by another 6% of GDP in the next four years, that the budget surplus will reach and remain at 4.5% of GDP, that nominal growth will return and remain at 4% are optimistic and there is plenty of room for disappointment. It thus seems inevitable that EU leaders will have to take further steps to help Greece at a later stage. Should we be alarmed that the deal is insufficient? Not really.

The most important statement in the Greek aid deal was probably that "Euro area Member States will consider further measures and assistance, including inter alia lower cofinancing in structural funds and/or further interest rate reduction of the Greek Loan Facility, if necessary, for achieving a further credible and sustainable reduction of Greek debt-to-GDP ratio, when Greece reaches an annual primary surplus." In short, politicians are well aware that they will probably have to do more for Greece at a later stage and they are already mentally preparing themselves to take such steps.

With few other options left EU leaders will probably have to accept a debt write-down. German finance minister Schäuble has apparently told French, Spanish and Italian finance ministers and IMF’s Lagarde that Germany would be willing to consider a Greek debt write-down at a later stage. However, there is a strong preference for not telling this to the public yet. We believe that in a year’s time (after the German elections) politicians in creditor countries will begin to let the public get used to the idea that some of the money lent to Greece is lost forever.

EU leaders thus appear ready to take a loss on the loans rather than forcing a Greek exit and/or a disorderly default. The reason is that such endgames would be more costly both economically and politically. We cannot fully rule out that the Greek population would choose to leave the euro voluntarily but we do not expect it. Adjustment within the euro area has been very painful. We doubt that the Greeks, who are more than halfway through this adjustment, would now like to find out what pains a euro exit may cause.

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