Greek deadlines are flying past like missiles over a barricade. Angela Merkel and Nicolas Sarkozy insist that time is running out. And yet nothing seems to come out of Athens except stasis and delay. So what exactly is the subject of the negotiations? And why the hold-up?
There are parallel sets of talks taking place. The first is between Greece and its bondholders over a deal to cut the value of Greece's €355bn (£294bn) sovereign debt pile by around €100bn. There are also negotiations within the Greek coalition over further domestic austerity measures. The technocrat Prime Minister, Lucas Papademos, is pushing for a further €4.4bn in cuts this year, equal to 1.5 per cent of GDP. But this has run into resistance from members of his coalition.
Other eurozone governments, which funded Greece with a €100bn bailout in May 2010, say they will not sign off on a further €130bn rescue package unless there is a deal both with bondholders over debt restructuring and among Greek politicians over more cuts. Germany has been particularly insistent on both of these points.
The real deadline, rather than the phoney ones that have been thrown around in recent weeks, is 20 March, when Greece is due to pay back €14.4bn to its creditors. Yet it is believed that a formal offer for the bond restructuring deal must be made by 13 February for Greece to be in a position to make the March payment. And unless the new European bailout package is signed off, Greece will simply not be able to pay its debts when they fall due next month.
Both sets of negotiations have hit the rocks over issues of self-interest and principle. The large banks that hold around €40bn in Greek bonds want to minimise their losses in the restructuring. And some hedge funds have also bought up Greece's devalued bonds specifically to make a profit, namely the difference between the price they paid and the written-down value.
The bondholders are also pushing for the European Central Bank (ECB), which acquired around €55bn worth of Greek bonds when it was trying in vain to stabilise the market in 2010, to take losses too. But some German politicians argue that to impose losses on the ECB would be tantamount to deficit financing of a sovereign state by the central bank – and thus a breach of European law.
The stakes are high. As the graph above shows, unless more than 50 per cent of Greece's bondholders sign up to a major restructuring, Greece's debts will not come down to a sustainable level, remaining well over 120 per cent of GDP for the foreseeable future. This is why Germany has been so firm on imposing large losses on bondholders. Berlin knows that, as the largest contributor of the eurozone rescue funds, it will end up having to put still more of its own money into Greece if the debt burden does not fall soon.
The negotiations on Greece's austerity are equally vexed. Political leaders, such as Antonis Samaras of the New Democracy party, have an eye on national elections due in April and want to distance themselves from austerity measures that are provoking intense opposition from the Greek population. But, again, the hold-up is not just driven by self-interest. It is not only Greek politicians who are objecting to further austerity as an economic strategy. An increasing number of economists are arguing that short-term budget cuts are simply making the economic situation in the country worse, rather than laying the foundations for recovery. Greece's economy is set to contract for its fifth successive year in 2012. Austerity seems to be crushing the economy, not curing it.
Many analysts now argue that though Athens should be compelled to push ahead with long-term structural economic reform, such as raising the pension age, liberalising labour markets and cracking down on tax evasion, what the country needs in the immediate term is a break from savage austerity. This classic Keynesian approach is, however, emphatically ruled out by German politicians, who insist that Athens must push ahead with austerity now, no matter how agonising, as the only route to a sustainable recovery.
"You must never do the opposite in the short term. Otherwise you will never regain credibility," insisted the German Finance Minister, Wolfgang Schäuble, at the World Economic Forum in Davos last month.
Germany does not subscribe to the theory that Greece's woes are down to excessive austerity. The crisis, Berlin argues, stems from a failure of Greek politicians to deliver on their reform commitments. And trust in those politicians is fading. That is why Germany floated a plan last month to transfer control of the Greek national budget to a special European commissioner – something that provoked a hostile reaction from Athens.
Not everyone can win. Someone – either Athens' creditors, the ECB, Greece's politicians or the German government – will have to give way if there is to be an agreement. And if they cannot agree? The prospect of a disorderly default for Greece is very real. The spokesman for eurozone finance ministers, Jean-Claude Juncker, made that clear in an interview over the weekend.
"If we determined that it's all going wrong in Greece, there won't be a new programme – and that means in March you'll have a declaration of bankruptcy," he said.
None of the large players involved in the talks wants that to happen, of course. For Greece, a default could be a prelude to exit from the eurozone, an economic shock that threatens to make Athens' present torment look mild. And a default by Athens would mean huge losses for major European banks and the possibility of financial contagion. Some say that Greece could be the new Lehman Brothers, the bankruptcy that sends the entire global economy over a cliff edge.
No one wants a Greek default. But, as things stand at the moment, that is the course on which Greece – and Europe – remain locked.
Portugal Next in line?
Where Athens goes, Lisbon will follow. That has been the concern of investors throughout the Greek debt restructuring talks. Eurozone politicians have insisted that the Greek writedown is unique. But Portugal is struggling too. Although its debt pile is not be onerous as Greece's (at 110 per cent of GDP, compared with 160 per cent in Athens) the Portuguese economy is also shrinking. And growth does not look likely to return soon, thanks to a significant competitiveness gap with Germany. That makes it likely that Portugal too will, at some stage, be unable to cope with its sovereign debt pile. That is why the yields on Portuguese bonds are around 13 per cent at the moment. Investors anticipate a Greek-style haircut. The Portuguese Prime Minister denied yesterday that this was on the agenda. But Lisbon is also reported to have been discreetly seeking advice on restructuring. The markets will, as usual, pay more attention to what politicians do than what they say.