Alternatives Open to the Greek Government to Alleviate Its Economic Woes - Essay Example

?Introduction Greece is the 32nd largest economy in the world with a GDP in of US$ 320 billion (CIA factbook). Greece became a member of the EU (European Union) in 1999 and member of the EMU (European Monetary Union) in 2001. Since 2009, the Greek economy has seen negative growth. By the time the global financial crisis came in 2008-09, Greece already had a high unemployment rate (7.7% in 2008) and a financial debt of more than its GDP (110% of GDP in 2008). As the previously easy access to credit became difficult and with the revelations from the new government of previous false statements of the economy, Greece faced an ever increasingly tight financial situation to the point that in April 2010, the EU and IMF made large bailout loans to Greece so that it could service its debt. The figures 1a below shows the evolution of some key macroeconomic indicators for Greece from 2006 to 2010 Figure 1a GDP growth and Unemployment for Greece from 2006 – 2010 Source: IMF The Economic problems for Greece The macroeconomic problems for Greece are aplenty. The GDP is contracting and unemployment rising. Most importantly, its debt has been constantly increasing for the last many years and as of end 2010, it was 143% of its GDP (as shown in Figure 1b below) with current deficit at 13% of the GDP. The current financial mess in Greece came to the open when the newly elected government announced in October 2010 that its current deficit had been falsely reported for the last few years. This revelation led yields on Greek government bonds and interest rates for new credit to rise astronomically, meaning that it was no longer viable for Greece to raise money from the market to maintain the levels of government spending that it had been doing since many years. The key priority now for Greece to overcome its economic woes is to bring its debt to more sustainable levels with a first target of not more than 100% of GDP. Figure 1b Gross debt as percentage of GDP for Greece 2006 to 2010 Source: IMF Option for Greece to alleviate its economic woes The Greek economy enjoyed growth from 2003-2007 largely due to high government spending. Historically, public spending accounted for a large part (>40%) of the GDP. Since public spending is not a luxury that Greece enjoys anymore, it needs to bring the economy back to growth through other means with the top priority of bring debt levels down to instil investor confidence in Greece. Because Greece is a member of the EMU, it has no longer the option to devalue its currency (to help make exports more competitive) or to control its monetary policy that best suits its own economy (interest rates and inflation). Given this, Greece could consider exiting the EMU - by exiting the EMU and dropping the Euro as its currency, Greece would revert to its original currency, the Drachma. It would no longer be under the control of the ECB for its monetary policy and it can devalue its currency and let its exporters get the competitive advantage. However, this would bring largely negative effect on the investors in Greece and would affect the investment coming into Greece. The overall effect may be a little to no change in the GDP but a largely disgruntled EU. So, Greece must look at options (with staying in the EMU in mind) aimed at reducing its overall sovereign debt and improving the economy. The possibilities for Greece then are: a) Reduce sovereign debt by restructuring the debt Clearly, sovereign debt is the biggest economic problem for Greece today. It is at a highly unsustainable level of 143% of the GDP. This means that any new loans for Greece would come at very high interest rates. Now, Greece could either simply default on its debt or it could try to restructure its debt. A debt default would mean even lower investor confidence which may not be a very positive sign for Greece. It could however, try to restructure its debt by: 1) Extending the maturity of its debt 2) Reducing the face value of the debt 3) Combination of both 1 and 2 above Extending the maturity of the debt means that Greece could buy more time for payout of its debt. While this would not decrease the net debt, the Greek government would be able to free-up more of the bailout money from EU and IMF for other purposes to support the growth of the economy. Evidence of this can be taken from the 2002 example of Uruguay when it got its US$ 10.75 billion restructured by having its maturity extended from its lenders. Uruguay was then facing similar problem of reducing GDP and high debt, but it wanted to still be able to service the debt. During a consultative period with the lenders, Uruguay was clearly told that the lenders would prefer to extend the maturity rather than reduce the face-value of debt. In 2003, Uruguay re-profiled its external debt and within five months, by October 2003, the Uruguayan economy as back on growth path (Papachlimintzos C). Reducing the face-value of the debt means that some lenders need to either write-off their debt in part or in full, or Greece could replace the existing bonds and credit agreements with new ones that offer lower return. This may not necessarily be very popular with the lenders but given the current extent of debt, a simple extension of maturity may not be enough and some lenders would need to be convinced to write-off or accept renewed lower interest debt instruments. b) Increase tax income As part of the austerity measures agreed when the EU agreed to give Greece a 110 billion Euro bailout, the Greek government increased the taxes. However, this actually reduced the total absolute tax income for the government in 2010. In 2007, the taxes were nearly 40% of the total GDP while in 2010, taxes were only 39.1% of the GDP even though the GDP was lower by 5.2% in 2010 compared to 2007 (Adelmann). Given that increasing taxes has not worked for the government of Greece, increasing taxes further may not be a good solution but Greece can still take some other measures to increase its tax income. According to Dr. Friedrich Schneider, a leading expert on shadow economy, Greece’s shadow economy is nearly 28% of the GDP. It has risen from 22.6% in 1989-90 to 27.8% in 2005. The shadow economy refers to under-reporting of the income for tax purposes. Greece's revenue from income tax was 4.7% of its GDP in 2007 compared with an EU average of 8%, EU statistics show (Chokshi). According to EU and OECD estimates, the present shadow economy in Greece amounts to nearly 20 billion Euros in annual income for Greece. In order to revamp the economy, Greece needs to take steps to be able to collect this tax which currently goes unreported. c) Decrease spending in certain areas (public sector wages and social benefits) The 2010 GDP figures for spending from the government show that wages to public sector employees (13.5% of GDP) and social benefits (20.9% of GDP) are the two largest spending areas of the Greek government (IMF 41). Nearly 1 in 10 Greeks is employed in the public sector. Greece could push for a temporary wages freeze (no increase) in order to reduce cost. Also considering the pension system requirements, Greece could opt to increase the retirement age so that the burden on social security payments for pensions is reduced. d) Privatise some government held companies The Greek government could consider selling or diluting its stake in some of the publicly held companies to private investors. Privatising government holdings would serve two key purposes: 1) Brings in much needed cash for the government – the government could sell either full or partial stake in public sector companies to raise money. 2) Reduces burden of wages – as public sector employees remain no longer on government payroll after dilution of stake by the government to less than a majority stake, the government no longer has the burden of wages to those employees. Among public sector holdings that the government could consider privatising are: railways, airports, sea ports, real estate assets, utility companies (gas, water, electricity) and banks among others. References Adelmann B. NewAmerican. 12 May 2011. Greece is Out of Options. Accessed 30 may 2011. http://thenewamerican.com/world-mainmenu-26/europe-mainmenu-35/7447-greece-is-out-of-options Chokshi N. The Atlantic. 22 Feb 2010. How Tax Evasion Is Complicating Greek Rescue Efforts. Accesed 30 May 2011. http://www.theatlantic.com/business/archive/2010/02/how-tax-evasion-is-complicating-greek-rescue-efforts/36365/ Dr. Friedrich Schneider. Shadow Economies of 145 Countries all over the World: What do we really know? 2005. P28 IMF. International Monetary Fund. IMF Country Report No. 11/68. 16 March 2011. P 38 – 45. Accessed 30 May 2011. http://www.imf.org/external/pubs/ft/scr/2011/cr1168.pdf Papachlimintzos C. Athens News. 1 May 2011. The options Ahead. Acessed 30 may 2011. http://www.athensnews.gr/issue/13441/40946 Read More