Hamish McRae: Greece gets its second bailout – but why should we trust this one to work?

Economic View
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A patch or a cure? A "game changer" to take Christine Lagarde's words, or, as many market participants seem to think, a deal that merely buys a few months' calm?

Or to put the point more bluntly, since the first Greek bailout did not work why on earth should we trust these same people who failed last time to succeed now?

It is always hard to calibrate these great set-piece financial announcements. The problem is partly that detail gets in the way of substance. But it is also that this is not just a single deal; it is part of a process. There will be further programmes, further debt relief, further controls on what the heavily indebted eurozone countries can and cannot do. And there will be the uncertainties of the global economic cycle and of the performance of European countries within that. So beware snap judgements – positive or negative.

Still, there are some things that can sensibly be said, and the first of these is that getting the eurozone through the first global downswing was always going to be difficult. Downturns expose the inherent weaknesses and imbalances that have built up in the boom years. As Warren Buffett famously put it: "It's only when the tide goes out that you learn who's been swimming naked."

Of course, it is not only the weak eurozone countries who have had their fiscal bottoms exposed: we still have a larger government deficit, relative to the size of the economy, than any eurozone country bar Greece and possibly Ireland. On some measures the US is in an even larger mess. But because the eurozone locks currencies together, a weak member cannot depreciate its currency and allow that to take some of the strain, has have the UK and the US.

On the other hand – and this is the second thing to be clear about – the political investment in the euro is huge and the firepower that the strong member states, particularly Germany, can bring to bear in its defence is considerable. If Germany had to pay off all the Greek debts it could do so; and it could at a stretch do Portugal's and Ireland's too.

My guess has always been that this political will would get the eurozone through the first global downturn but not the second. I'm not sure we are through this yet and it may be that this deal will buy only a few months of calm, but we will have to wait and see. So, what have we got?

First, Greece gets its second bailout of some ¤109bn, through to the middle of 2014. Second, the maturities of its loans from the European authorities have gone up from seven years to between 15 and 30 years, and Portugal and Ireland have got the same concessions. Third, the interest rate on all these loans has been cut from a bit under 6 per cent to 3.5 per cent. Fourth, the private sector is expected to provide another ¤50bn, maybe more, by rolling over debt and accepting a lower payback. Fifth, the eurozone authorities will take on much greater power to intervene early and make short-term loans should any other eurozone country get into a mess. And, finally, there will be a taskforce helping Greece in its structural reforms.

That is quite a lot of stuff, and, commenting on it, Howard Archer of Global Insight notes: "While this is by no means the resolution of the crisis ... there is a feeling that European policymakers may have finally got ahead of the curve and bought themselves time."

It does not, however, solve Greece's problems. The main graph shows some calculations by the economics team at Credit Suisse of what might happen to Greece's official debt under various assumptions. As you can see, even on the most favourable calculations government debt barely comes down to 100 per cent of GDP by 2020. Ireland and Portugal are not getting so much help, at least for now, and their projected numbers (see right-hand graph) are not much better come 2020.

So you still have huge indebtedness of the weakest eurozone countries for the foreseeable future – debt levels that inevitably inhibit growth. And of course there will somewhere out there be another global slowdown. As we have learnt to our cost in the UK, governments should not assume that growth will go on forever.

So what are the important bits of the package? To me, it is the last two of that list above that stand out. The eurozone is taking a big step forward in creating something akin to a European Monetary Fund, an IMF for Europe. And it is starting to intervene directly in the economic management of a member state.

We will have to see how all this develops but it looks as though the European Financial Stability Facility and its successor from mid-2013, the European Stability Mechanism, will take on a lot of power to act early should a country find the markets moving against it. But this will only work if problems are truly temporary.

The aim of the IMF was to help preserve the Bretton Woods fixed-exchange rate system by making funds available to countries that had got themselves into temporary balance-of-payments difficulties, allowing them time to correct their policies. But in doing so the IMF gave a stamp of approval for those policies, enabling countries to return to the market to borrow money at reasonable rates.

So in an ideal world this new "EMF" might evolve into a sort of financial police for the eurozone. But remember that one weapon in the IMF armoury is devaluation. If a country really is not competitive there is always that option, and it is not an option that is available within the eurozone.

As for the taskforce helping Greece, well, this is really the heavy hand of the lenders trying to make sure that Greece does not blow it and does generate policies that are likely to foster growth rather than inhibit it. It looks very much like Europe is taking charge of a sovereign country's affairs.

You may think this is no bad thing, but it was not what was on the can the eurozone countries thought they were buying when they signed up. The eurozone has taken another step towards a fiscal union. If Greece grows strongly in the coming years its people may put up with this loss of power. But if not – well, we will see.

With borrowing as high as last year, austerity is still the order of the day

With all this stuff happening in Europe, and the August deadline looming when the US runs out of borrowing authority – unless Congress can agree to raise the limit – the UK's precarious fiscal position has been rather eclipsed.

That is no bad thing because our borrowing in the first three months of the fiscal year is almost as high as it was last year: £39.2bn against £39.5 bn.

So you might say that, a year into the new government, we are is much the same mess as we were in the dying days of the last one. It is not quite as bad as that, because there was a one-off wodge of tax revenue from the banks last year, but these numbers do underline what a mountain we have ahead of us. Getting down from last year's £142bn to £122bn will be a stretch, particularly if growth disappoints.

It may well do. This week we get the first estimates of growth for the second quarter of the year, and the consensus expectation is of growth of something like 0.1 per cent, or less than 0.5 per cent annual rate. That is, of course, within a whisker of going negative again.

Regular readers will be aware of my views about the accuracy of GDP estimates, and that I feel that employment growth is a better indicator of what is happening than the early estimates of GDP. This coming set of figures will, in any case, be distorted by unusual weather, an extra bank holiday and by high inflation.

Nevertheless, it will be deeply unnerving if the numbers go negative and if they are stronger than that estimate above, take that with a pinch of salt too.

The better news is that retail sales in Britain have held up not too badly. Were it not for surging food and fuel prices they would be quite decently up over the past couple of years.

But with house prices at best flat and inflation still to peak some time in the autumn, austerity will, I fear, rule for a while yet.

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