Greece Needs Help but EU Bureaucracy May Be Fatal

It has been almost two months since S&P and Moody's downgraded Greece’s sovereign rating after it became clear that the Eurozone country may default on its government bonds. Yet, besides a guideline on how to solve the budget problems and a promise of support if things get out of control, the Euro Area members are not rushing to provide any financial help to its troubled pal. Moreover, many EU members seem to be underestimating the magnitude of problems in Greece which may prove to be a serious mistake in the months ahead.

In one hand, European officials ignored the early signs of Greece fiscal instability. Even on the day of joining Euro Area the nation did not comply with the Stability and Growth Pact rules. In fact, Greece had national debt equivalent to 103% of GDP in 200 and its government deficit was equivalent to 3.7% of GDP. According to the Stability and Growth Pact, members of the Euro Area should respect two rules: an annual budget deficit no higher than 3% of GDP and a national debt lower than 60% of GDP.

 On the other hand, EU members seem to be overestimating the Greek’s capacity to deal with their government debt. In fact, Greece took advantage of the EU membership to borrow money at historically low interest rates, ultimately driving its budget deficit to 12.7% of Gross Domestic Product and its national debt to 113% of the GDP. And instead of strengthening its fiscal position during good times, the country expanded government expenditures and improved social benefits to public service workers.

 Looking further, the Greek government's plan to cut the public deficit from 12.7% of GDP to less than 3% is not realistic. After all, given the current economic environment, tax revenues are not going to rise anytime soon. More importantly, the civil service pay and pension cuts will be very difficult to implement as any changes in social benefits in Greece usually trigger a wave of protests. In addition, even if Greece manages to refinance 8bn Euros of government bonds due in April and May it will be at a higher fee as the yield demanded to hold Greek 10 year debt rose to 320 basis points above German's equivalent.

Anna Fedec,
2/17/2010 12:29:47 PM