Hamish McRae: Greece will quit the euro - not just yet though

Economic Studies
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The Independent Online

Most of us can borrow more cheaply on our credit cards – and vastly more cheaply on our mortgages – than can the government of Greece. The interest rate on two-year Greek debt yesterday was 25 per cent.

It is worse than that: Greece cannot borrow from the markets at all. That 25 per cent is the rate at which current Greek debt is trading, a rate that, in effect, shuts out the country from issuing any new debt. Instead, to keep paying its bills it has to rely on the €110bn of loans it is getting from its eurozone partners and the International Monetary Fund.

The sequence of events is straightforward enough. A year ago, it had become clear that the Greek government could not finance its deficit, so it got the bailout. To do so, it had to agree to an austerity programme, with cuts in spending and increases in taxation. The idea was that it would be able to get itself straight enough to be able to borrow again from the markets in a couple of years' time.

That has not happened. Indeed, things have gone backwards, with 10-year borrowing yields at more than 15 per cent, more than double the level of a year ago. Now you can play the blame game if you want to, but that does not help. I am not saying it does not matter who is right and who is wrong; that would be absurd. But the plain fact is that the original bailout has failed, leaving two broad options. One is for the other eurozone countries to lend Greece more money and hope that in another couple of years there will be enough growth in the economy to stop the debts rising and for there to be some hope the country can gradually start to repay. The other is to agree that the debts cannot ever be repaid at their face value and for Greece to repay, say, only 50 cents in every euro. The first would be a refinancing; the second a default.

In practice there will have to be some combination of the two. The maths are such that the debts simply become too large relative to the taxing power of the country, reaching perhaps 150 per cent of GDP, maybe more. So there will eventually be a default. But meanwhile it looks as though it will get more loans to try to postpone that day. If you think that sounds a bit daft – why lend more money to a country that cannot repay what it has already borrowed? – you would be in good company. That is the collective view of the markets. But politicians and officials live in a world where, if you can patch things up for a bit longer, the real disaster does not happen on your watch.

So yesterday a board member of the European Central Bank, Dr Lorenzo Bini Smaghi, said: "Default or debt restructuring is a dramatic economic and social event for the country which experiences it – I would call it political 'suicide' – which leads many into poverty."

But it happens. There have been some 200 sovereign defaults since 1978, with investors typically, getting back only about half their money. The countries pay a price in that they cannot borrow for a while and when they can, they have to pay a higher rate on the new bonds. But it is not the end of the world.

There are, however, two ways in which Greece is different from nearly all those 200 cases of default. It is a developed country in Europe; and it is a member of the eurozone. So a default would have knock-on effects on other European countries, most obviously Ireland and Portugal. And Greece, unlike most countries that default, cannot devalue its currency as part of the restructuring and so quickly regain competitiveness. That is why the weekend story about Greece leaving the eurozone, though subsequently denied, has such resonance.

So what will happen? Well it is impossible to see the detail but you can see some of the outline. There will be further loans to Greece. And there will also in the next few years be some sort of default. The harder thing to be certain of will be whether Greece leaves the eurozone. My guess is that it will, but that this is still a way off, probably during the next global recession in, say, eight years' time. That will be messy as it will create all sorts of legal difficulties. But this is a sovereign nation that can re-establish currency sovereignty if it so chooses. My tip to Greece: do it when least expected and then do it suddenly – just as Ireland did when it broke the currency union with sterling on 30 March 1979.

One way to mend broken fences

The media spotlight has been on Pakistan and for the most obvious reason. Yet a brief visit last weekend convinced me that the economic story could be as interesting as the political one. Here is a country that 20 years ago was richer per capita than India but now lags behind. The gap is widening with growth below 3 per cent this year, while India belts along at 8 per cent or more. Yet, there is just as much entrepreneurial spirit, for the streets of Rawalpindi are just as bustling as those of Bangalore; just poorer. India's experience since the reforms of the early 1990s has shown how quickly things can turn round.

Frankly there is little sign of a turnabout and there are many reasons to be discouraged. But there is one really important initiative under way: reducing trade barriers with India. There were talks a couple of weeks ago on this, with the potential of quadrupling trade. The countries do some trade but often via a third country, for example Dubai, which is silly. There are further talks now taking place on building petroleum pipelines, improving road and rail links, electricity transmission lines and so on. Not easy, but fascinating.