Wolff: Greece will need a third loan agreement worth up to €20 bn.
There is a pressing need for the two parties to reach an agreement, moving away from the prisoner’s dilemma scenario to the solution upon cooperation scenario, said Mr. Guntram Wolff in an interview to the Crisis Observatory. Mr. Wolff foresaw that Greece will need a third loan agreement between 10 and 20 bn. euros, in order to meet its financing needs for 2015, while proposing a debt settlement that links growth to debt servicing. According to the leading economist, a social dimension could be included in the final agreement with the creditors, so that part of the funding will be directly used to cover the needs of the health system and to tackle poverty.
The Greek government said that it would not collaborate with the troika and won’t seek a second extension of the current programme. Do you consider this already as the end of the troika and what would this mean practically?
I think there are at least three reasons why the troika will not continue as it is. First, the ECB as an institution has become much higher about wanting to participate as a direct participant in these negotiations also because it is getting more and more engaged in sovereign bond purchases. The second reason is that the European Court of Justice, the general advocate has already said that the ECB should not be directly involved in the troika. So, there is a doubt how it can be structured from a legal point of view, with the involvement of the ECB, at least when there is an OMT programme. And lastly, I would argue that by now the opposition in Greece has grown so much that it is very difficult and probably counter-productive to do it.
The Greek government also says it needs time and a “bridge deal”. Do you think that the new Greek government and its creditors can strike a deal before the 28th of February and what would this deal be about as far as the conditions are concerned? What would be the consequences of failing to reach such a deal?
I think that the Greek government and the Eurogroup have to find a deal very quickly. It’s clear that money is flying from the country every day and when money leaves the country, it means that the economy deteriorates. And it’s of course a big state of uncertainty that it’s looming over everything. The ECB cannot provide emergency liquidity to banks in Greece for an unlimited period in order to use part of it for sovereign T-bills and bonds, especially if the Greek government as the finance minister Varoufakis has said declares to be insolvent. So I suspect there is some patience for a little bit of time in Frankfurt but that will be pretty soon over. That is why I think we need a deal very quickly.
As far as the conditions are concerned what would this deal be about?
I think Greece needs a deal and the deal needs concessions from both sides. But it’s clear is that the Greek government has completely overplayed its cards during the first weeks. I think there is no way that any of the demands that were on the table last week would be met, be at the debt cut, be at a significant increase in government spending. All of these things are unfeasible. The Greek minister of finance, has the legitimacy to negotiate but he has no legitimacy to ask taxpayers in other countries to pay for additional Greek expenditures. So to my mind it is quite clear that this would not go down well. By now everybody has understood and the Greek government has realised that that’s not the way to go.
Greek Debt. What’s the arrangement you would propose and under what conditions?
First of all, one has to negotiate and have reasonable discussion. And by reasonable discussion I mean that one acknowledges that the debt burden could become very high in the future depending on GDP development and that’s one of the big uncertainties that is looming over Greece now. Greece does not pay a lot for its debt now. It’s only 2% of the GDP so the interest rates are already very low. But there is this big debt level that could become very relevant in five or ten years. That’s what holds back the recovery, what holds back investment, that’s the big uncertainty for the Greek economy. And I think the best way to address it would be to reach a deal with the creditors in which the creditors would accept that if GDP developments are much worse than a base line scenario then the debt burden gets reduced, if GDP develops much better than a base line scenario then the debt burden does not get reduced, or even gets slightly increased so that you get a certain insurance premium, so to speak, when things get better. So in the first case the one side pays, in the second the other side pays. I think this would be a pretty fair deal. The exchange with bonds that are indexed to growth, that the Greek government suggested is very similar to what I’m proposing. A debt cut is impossible.
Finally, I think that part of the deal could be that the Europeans contribute with some direct funding to pay some essential elements that are important for example for the health system, to combat some poverty and so on. A more social dimension added to the programme.
The Greek government calls the new deal a medium-term recovery programme (balanced budgets and small primary surpluses along with ambitious reforms fighting tax evasion and corruption). Is this merely a third bailout programme (more money), or a precautionary credit line (safety net), or could it be something radically different?
I think in the short term Greece has a funding gap. So either the government doesn’t serve its debt repayments to the ECB and to the IMF, or it cuts government spending or it fills this funding gap with some other money. So, basically I thing we need some more resources. The needs could be up to 10 billions or even 20 billions because tax revenues have decreased substantially recently. The precautionary credit line was an option some months ago when Greek sovereign bonds were at 4,5% for 5-year bonds, so actually it was becoming conceivable that Greece would go back on the markets. This was basically undone by the Greek government and of course the popular support behind it. And that’s probably one of the reasons why we will now have to have a third programme. They will have to agree now on a bridge programme for the next couple of months to cover the immediate funding gap. A more permanent deal could follow and it could be the aforementioned one, indexing debt with GDP.
There is a lot of discussion lately about the reforms proposed by the Greek government focusing on tax evasion and combatting oligarchs. Do you think that there is a potential convergence there between the partners and the Greek government?
I do think that these things are very important. And it is quite appalling to think that a very rich Greek citizen would get away without paying taxes while lower middle class tax payer in France would pay for some of the expenditure that Greece has done before. So that’s just not acceptable. Historically, in severe crisis periods income inequality goes down, basically because the top income gets taxed more. And in Greece we don’t see that yet. So this is clear something that it has to happen. What I see is that the new government has a lot of political and popular support for it. It’s very difficult to achieve it, because there is a lot of resistance. But I really hope that it will achieve it and for this it will get a lot of support from its partners.
Do you believe that reforms linked to the internal devaluation policy (for example in the labour market) have worked up to now? Do you think that reforms to boost demand, which to some degree undo previous supply-side reforms, like for example the increase of the minimum wage that the Syriza government has announced, are going to have a positive effect on the Greek economy and could they undermine its competitiveness?
That’s a very good question and to be honest I don’t have a full answer to it.
I do think that Greek wages have grown too much prior to the crisis and I do think that it was necessary to correct them. One problem is that this significant correction that has happened in wages in the private sector –my estimate is about 15% during the crisis, since 2009- hasn’t helped exports. And the reason is that the competition is very low and product markets remain very regulated. I think what would be very important for the new government is to make sure that the oligopolistic structures that exist in many parts of the economy get broken up and introduce competition. And when it does that it will see that prices for exports could fall and then actually exports will pick up.
In your opinion, is this negotiation a game of chicken, as it is often described?
I think last week indeed it looked like a game of chicken and that’s an unpleasant situation for everybody involved. I personally think that both sides understand that a cooperative solution is better. Now what we know from game theory is that cooperative solutions are not always happening. But still they are better. So I think what we are working on now is how to move from the prisoner dilemma scenario to a cooperative solution scenario. And I do not think that this is unfeasible.
The Greek government says that there is a new mood in Europe and that Europe has changed its policy priorities, abandoning austerity for growth. Do you agree with this assessment? Do you think that the new quantitative easing programme of the ECB and Mr. Juncker’s investment programme signify such a change of policy? Do all these initiatives imply a relaxation of fiscal discipline?
I would be very cautious to infer anything on Greece from the rest of the Eurozone. The Greek situation is quite a special one and I think it is special in many respects. It’s quite remarkable how different the Greek economy has performed in comparison with all the other programme countries. It’s amazing if you look at Portugal, Ireland, Spain. All these three countries had spectacular increases in exports so their adjustment has happened much more strongly than in Greece and in much better way. Spain by now sees 200.000 new jobs per year. And it is true also that in different countries we see a political mood for change in policies. I personally think that a bit of flexibility has been introduced and the fiscal adjustment that we have seen has become virtually inexistent for the Eurozone as a whole. In 2014 there was a fiscal consolidation of 20 billion for the Eurozone as a whole that’s 0,2% of GDP and for 2015 it’s even going to be less. I do expect that member states will also contribute to the Juncker plan to increase a bit the government spending. In that sense, yes, the mood is changing.
Finally, what’s your idea of the worst-case scenario and which are the key-factors that could cause –or prevent it?
The worst-case scenario is that Greece tries to hold the rest of the Eurozone ransom and the rest of the Eurozone will not accept it. I am quite convinced of this. And then Greece could leave the Eurozone really quickly, much more quickly than some people anticipate. And then to be honest the situation in Greece could be very bad for at least 2 years. Because the new currency would depreciate very massively, oil imports would become very expensive, exports would not really pick up because there is just so little export industry anyway, so I think the economy would be in really bad shape. So, it wouldn’t be a very good scenario for Greece and it would’t be a very good scenario for the Eurozone, either.