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13.03.12

Special Series: European Economies At Risk - Greece

Stratfor

Greece is on the periphery of Europe. It does not have close trade relations with the rest of the European Union, and its geography makes it difficult for the country to develop a domestic industrial base that could compete with the northern European countries, much less the wider world. These deficiencies mean Greece must depend on an outside supporter, and the only asset Greece can offer such a supporter is its strategically important location in the eastern Mediterranean Sea.

 Greece has benefited from the European Union through several channels for more than a decade. Since Europe currently has relatively good relations with Russia and Turkey, Greece's importance as a strategic outpost in the east is declining. Furthermore, it is becoming costlier to continue to support Greece because the core of Europe that exports capital to Greece is facing its own problems. The main reason for the European Union's continued concern about Greece is the European financial sector's heavy exposure to Greek public debt.

Greece's biggest challenge in the near future is to maintain strong enough ties with the European Union to keep the bloc convinced that cutting Greece off would not be worth it. This means Greece must strike a delicate balance between threatening to default, which likely would cause a financial disaster in the rest of Europe due to contagion, and abiding by the rules set by the European Union to ensure continued EU aid to Athens. Although the European Union is acting as Greece's outside sponsor, the Greek economy will not be able to grow if it is in the same currency union as the more competitive northern European countries. Thus, exiting the eurozone seems to be the most likely outcome in the long term. Because leaving the eurozone and potentially the European Union will be a painful process that no politician would want to be held responsible for, that process is being delayed.  

In the meantime, Greece's creditors will work harder to isolate the country's political chaos in preparation for severing Greece from the European system. Thus Greek politicians will make bolder moves (such as calling for a referendum, as former Greek Prime Minister George Papandreou did) to ensure they are heard within the European Union and to highlight the contagion risk Greece still poses to the entire eurozone.

While the markets and decision makers deal with other European countries' troubles, Greece's turmoil will continue to be an important factor as new numbers emerge and more bailout packages are discussed.

Domestic Conditions

Economy

Greece has been in recession since the third quarter of 2008. Since then, its economy has contracted by 20 percent (7 percent in 2011 alone). The forecast contraction for 2012 is 3 percent but likely will be larger.

Greek government debt has increased by around 150 percent over the last decade; currently, the government's general debt is about 350 billion euros ($459 billion), or approximately 160 percent of its gross domestic product (GDP). After the financial crisis began, bond yields rose so high that Greece was no longer able to get funding through the international markets. In mid-2010, the so-called troika -- the European Commission, International Monetary Fund (IMF) and European Central Bank (ECB) -- arranged for the first bailout package for Greece at 110 billion euros. As of last week, Greece is set to receive a second bailout package worth 130 billion euros to recapitalize its banks and repay its debt. A further 107 billion euros in aid will be granted through investors' voluntary write-downs in Greek debt holdings. The aim of these bailout packages is to get the Greek debt down to 120.5 percent of GDP by 2020. However, the targets set out in the second bailout package likely will not be achieved. The latest leaked reports from the IMF indicated that a debt level of 135 percent of GDP is more realistic than the 120.5 percent target.

The troika hopes that Greece grows out of the crisis because of an increase in external demand for Greek goods and services. However, the hoped-for positive trade balance in 2014 is unlikely to materialize. Greece has had a negative trade balance since the early 1960s. Greece only exports the equivalent of 5 percent of GDP to other EU countries and only approximately 10 percent to the world. Data from 2009 showed that Greece accounted for 3.3 percent of global capital imports.

Greece's economy is expected to weaken further as Greek banks, which held approximately 40 billion euros in public debt before agreeing to a haircut, have continued to restrict lending. These banks are struggling with lower deposits (in 2011 deposits dropped by nearly 15 percent), a high number of nonperforming loans (around 14 percent in 2011) and require outside assistance to recapitalize (currently, approximately 30 billion of the 130 billion-euro bailout package will be used to recapitalize Greece's banks).

Adding to the weakening domestic demand for goods and services is an aging population and an outflow of young, well-educated workers who see no future in Greece and are moving into the northern European labor markets. The troika still sees Greece's long-term economic growth at 1.75 percent, but that is under the assumption that Greece will remain in the eurozone and European Union.

Greece has already implemented harsh austerity measures. Between 2009 and 2010, Greece cut its budget deficit by nearly 5 percent of GDP from 15.4 percent to 10.5 percent, the largest fiscal consolidation by a member of the eurozone or Organization for Economic Cooperation and Development. Athens is expected to take austerity even further. Certain economic sectors, such as the defense budget, have not really been touched yet, and in 2012 alone Greece is expected to cut approximately 55,000 public jobs (ultimately aiming to cut the government workforce to 600,000, or 12 percent of the labor force, by 2015).

However, it is unlikely that the targets that the troika set and Greece has agreed to will be met. Greece's recovery depends largely on external factors, and as the past two years have shown, there is a good chance that Greece will relax the implementation of austerity measures. Politicians in Europe have already cautioned their parliaments that the second aid package for Greece might not be the last.

Politics

During summer 2011, Greek authorities had difficulty implementing the agreed-upon austerity measures. Social resistance to the measures intensified as the economy weakened and opposition attacks on the program increased. In early November 2011, Panhellenic Socialist Movement (PASOK) leader Papandreou resigned as prime minister after an effort to broaden support for the austerity program through a referendum failed mainly due to outside pressure. A three-party coalition government comprising PASOK and the opposition New Democracy (ND) and Popular Orthodox Rally (LAOS) parties was created with a promise to hold elections in early 2012.

The coalition appointed a technocrat, former ECB Vice President Lucas Papademos, as prime minister until the new elections. Unlike the government in Italy, Greece's government is not entirely technocratic since politicians from all of the main parties are in the Cabinet.

Greek elections are expected to be held in April, but the exact date has not been confirmed. ND pushed for the elections in return for supporting the technocratic government, but most recent polls show that support for ND is decreasing while fringe parties (the leftist coalition comprising the Democratic Left Alliance, the Communist Party of Greece and the Coalition of the Radical Left) are gaining support.

Historically, power has shifted between Greece's two largest parties, PASOK and ND. Although the parties form the political establishment, since they are part of the government that is implementing further austerity measures it will be difficult for one of the parties to profit from the other's weakness in any election. Most recent polls show that the fringe parties are quite likely to gain enough votes to be included in a future government. This would make further collaboration between Athens and the troika more difficult.

Because Greece's political future is so uncertain, outside creditors will try to separate the financial crisis from the political situation. Among the tools that could be used to accomplish this are a more permanent presence in Greece through a special commissioner who would oversee the government's financial and economic policies, and a stricter control over the government's spending by gradually feeding the Greeks aid instead of paying out large sums at once (one condition set by the troika is that Athens is supposed to put a certain amount into an account that is not allowed to be used for anything but debt, but this is indirect control).

Society

Since 2008, the recession and austerity measures have greatly affected the Greek population. Unemployment has risen from 7 percent in 2008 to 21 percent, with unemployment among youth at 51 percent. The situation is expected to deteriorate in 2012. Greece is dependent on tourism, but figures from summer 2011 showed that the holiday season did not bring relief to the labor market.

Greeks are earning less, but the government's strategy to improve its finances focuses heavily on increasing taxes. Greek authorities have long struggled with tax collection, and as taxes grow it is even more likely that the population will avoid paying them. The informal economy, which has a strong history in Greece, is likely to grow, making it harder for the government and the troika to collect the necessary revenues. However, the growth in non-registered economic activity will also act as a stabilizer because it will allow Greeks to continue with their daily lives through bartering.

A second stabilizer is the pension system. Greeks have relatively stable family structures, and therefore money trickles down to the younger generation through pension payments. However, further cuts to pensions are expected (Greece spends about 15 percent of GDP on pensions, which is above the EU average of 13 percent and the U.S. average of 5.6 percent). These cuts could lead to social unrest because they will have effects outside of Greece's retired population. 

Social unrest has increased greatly in Greece since 2010. At the height of protests in June 2011, approximately 200,000 people took to the streets in a single day. The number of strikes and protests increased in 2011, and the demonstrations turned violent in late 2011 and early 2012. The number of violent protesters is still low, but Greece has a history of anarchist movements that likely would take advantage of the social unrest, so more violence can be expected.

Greek labor unions have thus far been very effective in staging protests and strikes, but as the economic situation worsens, fewer people can be expected to be willing to take to the streets for the unions' cause. The largest protest groups likely will be the public sector workers who are most affected by the austerity measures.

The military is important to watch. Austerity measures thus far have not affected the defense budget much; Greece still spends more on its military in terms of GDP than other EU countries do. However, Greece's military rule only ended in 1974, and it is uncertain how the armed forces might react to budget cuts and whether the military will add to the instability by entering politics.

Greece's social unrest likely will not die down soon. It will be important to see whether unrest emerges among different social groups or follows different themes from those seen so far. Protests so far have not been directed against foreigners, but anger potentially could be directed at immigrants.

Source: Stratfor

Post-Crisis World Institute