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No Painless Solution to Greece’s Debt Crisis
Programme Paper
Vanessa Rossi and Rodrigo Delgado Aguilera, February 2010
- Greece currently faces a crisis on two fronts: there has been a long-run build-up of public sector debt due to persistently high budget deficits, and a very rapid build up of excessive external debt due to several years of massive current account deficits. Greece has been living beyond its means and must immediately cut spending and imports to check its unsustainable deficits.
- The government went into the global economic crisis with an already high budget deficit and public sector debt above 100% of GDP, much of which is held by EU banks. The global crisis compounded the problem as the government sought to boost growth rather than prioritising fiscal prudence - hiding the overshoot in the budget until late 2009.
- Whether Greece adopts austerity measures or has austerity imposed by financial market turmoil, there is little option but to cut the twin deficits rapidly, implying a steep recession and drop in imports. Achieving both growth and fiscal consolidation seems highly unlikely - growth will have to give way.
- Close monitoring of progress by the European Commission should provide the credibility Greece needs to meet its financing requirements through the market (at least this year) but if Greece still fails to control its runaway finances, it will have no choice but to seek a bailout.
- The most drastic solution - abandoning the euro as a prelude to devaluation - would not change the requirement to cut the twin deficits since short-term export competitiveness is not the key issue and opportunities to boost exports (including tourism) are quite limited, especially as the European economy remains weak. Those who see exit from the euro as attractive should also recall the instability generated by historic episodes of devaluation.
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