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Eric Reguly, The Globe and Mail
May 2, 2010

Greece clinched a €110-billion ($150-billion) bailout designed to shield the battered country from debt speculators and restore confidence in the ailing euro. But the sweeping reforms demanded by the lenders threaten to make Greece’s recession longer and nastier than expected.

The historic deal among finance ministers of the 16 nations in the currency bloc — the first such aid package for a member since the euro zone was created in 1999 — will provide the first emergency loan payment before May 19, when Greece must redeem a bond series. The EU is contributing €80-billion of the total, at an interest rate of about 5 per cent. The International Monetary Fund will supply the rest.

For Greece, the price is a program of tough spending cuts and tax increases. The measures include the extension of a public sector wage freeze until 2014, the elimination of a bonus equivalent to two months’ salary for many civil servants, sin tax increases and a boost in the value added tax (equivalent to Canada’s GST) to 23 per cent from 21 per cent.

“Our priority is to avoid bankruptcy,” Greek Prime Minister George Papandreou told a televised emergency cabinet meeting on yesterday. “That is a red line that cannot be crossed.”

The completion of a bailout package ends weeks of uncertainty and greatly diminishes the threat of a potentially catastrophic Greek default in the next two to three years, said UniCredit Group chief economist Marco Annunziata. This, in turn, should remove some of the pressure on Spain and Portugal, two other debt-swamped countries whose bond yields rose substantially as the Greek contagion spread.

The size of the EU and IMF commitment “is enormous, tangible proof that Greece’s predicament is extremely serious and poses an existential risk to the euro zone itself,” Mr. Annunziata said Sunday. But Sunday’s development does not necessarily mean the European debt crisis is over yet. “I still believe Portugal and Spain will need to put on the table stronger measures to bolster their fiscal and growth performance, to avoid coming under renewed pressure in the coming weeks and months,” he said.

France and Germany, the two biggest sponsors the bailout’s EU portion, will need parliamentary approval to release their contributions. Wolfgang Schaeuble, the German finance minister, told reporters Sunday in Brussels that parliament was prepared to pass legislation on the Greek bailout by Friday. “All Europeans — and Germans are Europeans — have the same goal [to defend] the stability of the euro zone as a whole,” he said.

While economists said the new taxes and spending cuts were both necessary and long overdue, they could prolong Greece’s recession. New figures from the Greek Finance Ministry predict gross domestic product (GDP) will fall 4 per cent this year, compared with the IMF’s latest forecast of a 2-per-cent contraction, followed by a 2.6 per cent decline in 2011. Growth in later years would be modest, at best.

The debt, meanwhile, is forecast to soar from last year’s 115 per cent of GDP to almost 150 per cent by 2013, before coming down somewhat. That’s in good part because the annual budget deficit — 13.6 per cent last year — is not expected to fall below the EU’s 3-per-cent limit until 2014, a year later than the previous forecast.

The hefty debt load may be unsustainable if the recession reduces tax revenues to the point that debt payments come under threat, possibly triggering a debt restructuring.

In an interview, Michael Mitsopoulos, the economist in Athens at the Association of Greek Industries, said the EU-IMF package should be enough to roll over Greece’s debt and fund its deficit for the next three years. But all bets are off if “the economy goes into a deep recession and the tax revenues go down.”

The bigger question, he said, is whether Greece will use its holiday from the public debt markets to overhaul its economy and gain competitiveness. “The country has been given the gift of time. Will it use it wisely?”

The austerity measures have to be followed by slimming down Greece’s bloated bureaucracy, reforming the pension system, cutting subsidies to loser state-controlled companies, clamping down on tax evaders and streamlining business permits system, Mr. Mitsopoulos said.

Economists are not entirely hopeful the reforms will be made. For instance, they note that efforts to liberalize Greece’s uncompetitive trucking and logistics industries seem to be going reverse.

Mr. Papandreou, the Prime Minister, made no effort Sunday to sugar-coat the terms of the EU-IMF loan conditions. “These sacrifices will give us breathing space and the time we need to make great changes,” he said. “I want to tell Greeks very honestly that we have a big trial ahead of us.”

Mr. Papandreou’s political will to implement tough measures will be tested by the expected wave of protests and strikes, as civil servants — who make up big chunk of Greece’s job market — see their spending power fall. On Saturday in Athens, tens of thousands of workers took to the streets to protest the cutbacks. A nationwide strike has been called for next Wednesday.

Private-sector workers do not seem to share the anger of their civil service counterparts. “The private sector has a lot to gain from a restructuring of the economy,” Mr. Mitsopoulos said.

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