German proposal for Greece’s compliance: accelerating eurozone exit
January 28, 2012 31 Comments
At the top of my list of to do’s for the past few weeks has been to update the post on Greek PSI that I wrote just before Christmas to include some more recent developments, such as the prospect of ECB participation. Last night, Peter Spiegel from the Financial Times (@SpiegelPeter) published the German government’s proposal for Greece’s “improvement of compliance” with the terms of the bailout, and all of a sudden Greek PSI positively pales in comparison. According to Germany’s proposal, whatever the result of the PSI deal, Greece will need to “legally commit itself to giving absolute priority to future debt service” and “accept shifting budgetary sovereignty to the European level”. If the Greek government is not willing to do this, the troika would presumably turn off the taps of bailout money and Greece would default. With no access to market or official financing, Greece would be forced to exit the eurozone.
Germany’s proposal for Greece caught most by surprise, but we shouldn’t be so shocked by it. The ruling German Christian Democrat party (CDU) already published this idea in its November 2011 proposal for “A Strong Europe—A Bright Future for Germany”. According to this proposal, if a country is unable to meet its debt obligations, “the European Commission should provide the affected eurozone country with a commissioner responsible for budgetary savings, who would oversee the use of budgetary funds and the implementation of any restructuring measures that may be required.” The CDU goes on to propose that a clause should be created in the Lisbon Treaty to allow a country to voluntarily withdraw from the eurozone without exiting the EU.
This clause for a voluntary eurozone exit increasingly seems like a preview for things to come in Greece. Greece is currently in the midst of negotiating a PSI deal, without which it faces a hard default when it must roll over €14.5bn in debt on March 20th. There are only around 45 business days left before this deadline, an extremely tight schedule even without the huge distraction of Greece fighting for its fiscal sovereignty. The best case scenario is that a PSI agreement is reached, but will that really make a difference? If the Greek government does not sign up to the German proposal and Germany does not back down, a hard default by Greece is still likely.
Is the Greek government likely to agree to transfer its fiscal sovereignty to Brussels? Some Greeks have argued that the population would be better off if Greece’s fiscal discipline were in the hands of Eurocrats rather than corrupt Greek politicians. I think it highly unlikely a bureaucrat chosen by the Eurogroup would have more success changing the political culture and Greek attitudes towards corruption, wasteful spending or tax evasion any better than the Greek government can. Regardless, the Greek government has so far indicated it is dead set against the idea. When asked about the German proposal, one Greek government source responded “there is no way we could accept such a thing.” The government released an official statement saying responsibility for fiscal policy rests solely with Greece.
If the Greek government rejects the German proposal and the troika refuses to transfer any more tranches of funds to Greece, Greece will default. Without any access to market or official funding and running a primary deficit, Greece would be forced to abandon the common currency and reissue the drachma for the government to carry out basic public services and continue to pay civil servants. Greece would also be forced to exit the eurozone in order to regain competitiveness and return to growth.
I have long thought that the troika would cut Greece loose and let it default and exit the eurozone once eurozone banks had been sufficiently firewalled. Perhaps this aggressive proposal by Germany is one of the unintended consequences of the ECB’s three year long term refinancing operation (LTRO). If eurozone banks have as much access to cheap, three-year ECB funding as their collateral allows, perhaps Germany and the troika have decided that eurozone banks can survive a Greek default. Greece is clearly insolvent and must leave the eurozone to eventually return to growth. The German proposal may have accelerated the inevitable.
For more details on the potential implications of the German proposal for Greece, please see this analysis by RGE.