Europe on tenterhooks as Greeks decide their future

Greece’s day of reckoning has arrived. Today millions of Greeks will cast their vote in a referendum, which could shape the future of the birthplace of democracy and the rest of the European Union and the single currency.

Greek Prime Minister Alexis Tsipras called for a snap referendum after months of negotiations with the country’s creditors descended into acrimony, with his government refusing the creditors’ demands.

Voters will today decide whether or not to accept the proposal put forward by the troika (the European Commission, the International Monetary Fund and the European Central Bank).

A day after Greece became the first developed economy to default on debt to the International Monetary Fund, Tsipras accused Europe’s leaders of attempting to “blackmail” Greek voters by denying the country debt-relief.

In a televised address, Tsipras urged voters to vote no, adding “the sirens of destruction are blackmailing you to say yes to everything without any prospect of exiting the crisis”.

The left-wing Prime Minister is hoping for a strong mandate by the people to strengthen his position at the negotiating table. However, he said that if the people vote yes he would resign.

In a twist of events on Thursday, the International Monetary Fund (IMF) published a document which revealed a deep split with Europe as it warned that Greece’s debts are “unsustainable.”

The IMF said Greece needs €50 billion of extra funds over the next three years. It said that Greece requires large-scale debt relief to create “a breathing space” and stabilise the crippled economy. “Even with concessional financing through 2018, debt would remain very high for decades and highly vulnerable to shocks,” the IMF said.

Why is Greece in such a mess?

The Greek economy was one of the fastest growing in the Eurozone from 2000 to 2007: during this period it grew at an annual rate of 4.2%, as foreign capital flooded the country.
But the Hellenic country became the epicentre of Europe’s debt crisis after Wall Street imploded in 2008. With global financial markets still reeling, Greece announced in October 2009 that it had been deflating its deficit figures for years, raising alarm about the soundness of Greek finances.

Suddenly, Greece was shut out from borrowing in the financial markets and by the spring of 2010, it was veering towards bankruptcy, which threatened to set off a new financial crisis.

To avert disaster, the troika issued the first of two international bailouts for Greece, which would eventually total more than €20 billion. In return, creditors imposed harsh austerity terms, requiring deep budget cuts and steep tax increases.

Where did the bailout money go?

Almost all the money owed by Greece has been used to pay off private banks, with only 8% making its way into the economy, according to the Jubilee Debt Campaign.
Most of the money went to the banks that lent Greece money before the crash and only a small fraction of the €252 billion the creditors gave Greece in the 2010 and 2012 bailouts could be used to soften the blow of the 2008 financial crash and fund reform programmes.

A Jubilee study has shown that since 2010, the IMF, European governments and the European Central Bank have lent €252 billion to Greece. Since then, Greece has paid around €150 billion to foreign banks, mostly German and French based banks, and a further €48 billion to Greek banks.

Another €34.5 billion were handed out as ‘sweeteners’ to speculators to get them to accept the 2012 debt restructuring.

Back in 2010, nearly all government debt was owed to private banks and financial institutions. Today 78% of Greek debt is owed to the public sector, primarily Eurozone governments.

What did the creditors propose?

Tax increases and spending cuts are among the measures the troika is now demanding from the Greek government. The most politically sensitive of the proposals proposed by the creditors are the cuts to pensions.
The plan also calls on Greece to “recognise that the pension system is unsustainable and needs fundamental reforms,” to fully implement a 2010 pension law and to start introducing cuts from 2015.

A major bone of contention is the proposal to phase out the “solidarity” top-up grant that some 200,000 poorer pensioners get, cutting the grant for the wealthiest 20% of recipients and removing the scheme completely by 2020.

Moreover, the troika wants Greece to increase the retirement age to 67 by 2022 and create strong disincentives to early retirement.

The proposal also suggests broadening the VAT base at a standard rate of 23%, and would include restaurants, and catering. The creditors also proposed a reduced VAT rate of 6% on pharmaceuticals, books and theatres, an increase on tax on insurance and the elimination of tax exemptions for Greek islands.

Why did the Greek government refuse the deal?

In January the newly elected left-wing government promised to end years of austerity measures while remaining a member of the Eurozone.

Pointing to the nation’s 25.6 percent unemployment rate, Tsipras argues that Greece can’t handle more austerity.

This week, Greek finance minister Yanis Varoufakis explained that the negotiations broke down because Greece’s creditors refused to reduce the country’s un-payable public debt and insisted that “it should be repaid ‘parametrically’ by the weakest members of our society, their children and their grandchildren.”

What are the Greeks demanding?

On Tuesday, Greece sent a new proposal for budget cuts and policy overhauls as part of a request for a new €29 billion two-year bailout using funds from the European Stability Mechanism and not part of the current programme which expired on Wednesday.
Tsipras agreed to accept most of the troika’s demands for taxes and pension cuts and asked for a new €29 billion loan to cover all debt service payments in the next two years.

However, even if negotiations do restart after the referendum, German Chancellor Angela Merkel has made it clear that any talks on a new bailout would have to start from scratch with different conditions.

What will happen?

Greece is still in the single currancy, and a defiant Varoufakis said “Greece will stay in the euro,” adding that deposits in banks were safe.  

“Creditors have chosen the strategy of blackmail based on bank closures. The current impasse is due to this choice by the creditors and not by the Greek government discontinuing the negotiations or any Greek thoughts of Grexit and devaluation. Greece’s place in the Eurozone and in the European Union is non-negotiable,” Varoufakis said.

Greek banks appear to have enough cash to pay €2bn worth of welfare and pension payments this week and a large public sector pay bill.

What is less clear is the amount of funds left in the banking sector to repay depositors should a dispute with the EU drag on for several more weeks.

In the worst case scenario, the Greek central bank will be forced to switch to a new currency, most likely at a lower value than the euro.

If Greece does exit the euro, it can work out a long-term debt management plan with its creditors, probably with a hiatus for a year or two while the country gets its house in order and with a discount on the original sum owed.

Is it that simple?

No. Greece and Europe are heading towards uncharted waters. Given the nature of the euro, if Grexit does materialise the currency will remain intact, or at least that is what the remaining members will hope. Athens could rely on the large number of euros in the economy and the stock of funds sitting inside the banking system to stagger on for several weeks, especially if the European Central Bank (ECB) maintains a facility for trading euros with domestic banks.

But if the Greek central bank fails to repay a €3.5bn loan on 20 July, the ECB could demand more collateral from Greek banks for the €89 billion of Emergency Liquidity Assistance and possibly switch off access to euros altogether. Without access to euros, Greek banks would struggle to remain open.

If Athens is denied access to euros, it could be forced to issue IOUs to suppliers and possibly employees and welfare recipients, passing a law forcing businesses to recognise the IOUs as currency. Then Greece could resurrect the drachma and start printing new currency.