A Pyrrhic Deal: How Greece’s Creditors Won Battle But May Have Lost War – Analysis


On August 11, the Greek government and its creditors agreed on a memorandum of understanding (MoU) on a third bailout. The 29-page document, which was leaked to media a day later, is predicated on broad and deep reforms and a timetable. It seeks to restore “fiscal sustainability,” protect “financial stability,” foster “growth, competitiveness and investment” and support “modern state and public administration.”

Pro-austerity advocates consider the MoU ambitious; cynics see it as aspirational. If the deal is ratified by other Eurozone countries, it could ensure up to €86 billion in financing over the next three years.

How did few summer weeks result in a deal that may replace one Greek crisis with another?

To Grexit or Not, That’s the Question

The third bailout is the result of more than six months of turbulent negotiations, which pushed Greece back into recession, left its banks subject to stringent capital controls, while delaying any action to reduce Athens’s huge debt burden until the fall.

As Greece’s primary creditors, the so called troika – the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) – presented their June 25 proposal, which pushed for very harsh austerity policies, Prime Minister Alexis Tsipras resorted to a referendum, which took the creditors by a surprise. Tsipras needed national unity and a better hand for the talks.

In contrast, Brussels made no secret about its support for the Greek opposition. Before the referendum, the Eurogroup’s uncompromising president Jeroen Dijsselboem warned that “If [the Greek] people say they don’t want [the creditors’ reform package], there is not only no basis for a new program, there is also no basis for Greece in the Eurozone.”

In the referendum, some 61% of Greeks voted against the creditors’ proposal, only 39% for it. Greek party leaders signed a joint statement, expressing common goals, including the securing of funding in exchange for reforms and seeking debt relief. It was a triumph for the Syriza-led coalition government that had come to power only in January; after 7 years of contractions.

However, the Eurogroup’s pressure did lead to the replacement of finance minister Yanis Varoufakis, whom Brussels found too “radical,” with Euclid Tsakalotos, Greece’s key negotiator in aid talks with creditors.

But was there any room left for a compromise between Athens and its creditors? Not really. Prime Minister Tsipras demanded a “fair compromise” requesting a 3-year bailout. However, Greece’s creditors remained fixated to the substance of their June 25 proposal. As Athens was working on its reform proposal ahead of a meeting of all 28 EU leaders, an ultimatum came with the EC head Claude Juncker’s warning. “We have a Grexit scenario [the exit of Greece from the Eurozone] prepared in detail.”

If Athens opposed the creditors’ proposal; Greece would be allowed to default. The creditors betted that, after hundreds of billions of euros had been spent on firewalls, a meltdown would harm Greece, but Europe would avoid a contagion. That’s how Sunday July 12 became the “make-or-break” day for Greece’s continued membership in the Eurozone.

After marathon talks, the Eurozone leaders agreed to give Greece up to €86 billion of new bailout loans, but only in return for new round of extreme austerity measures.

The Price of the EU Membership

Ironically, now Greek parliament was compelled to accept the pension overhauls and sales tax increases that Greek voters had just rejected in the referendum. The final rescue program contains measures that far exceed the oversight and external control other Eurozone bailouts, including a €50 billion fund in state-owned assets which will be privatized and non-performing loans (loans not being repaid to banks).

As far as Athens and Greek people were concerned, that was the price for staying in the Eurozone.

What surprised many observers was the insistence of Germany – against France – on punishing austerity terms that have already wrecked Greece and much of Southern Europe, while eroding fiscal stability in Northern Europe and leaving Eastern Europe in a growth limbo. The pro-austerity views, however, can be attributed to debt ownership.

Greek debt is owned by the key Eurozone economies – Germany (27%), France (17%), Italy (15%), Spain (10%) and the Netherlands (5%); as well as the IMF and the ECB together (15%). The burden is particularly hard for small and fiscally conservative euro economies, such as Belgium (€7.5bn), Austria (€5.9bn) and Finland (€3.7bn), which themselves are under increasing economic pressures.

Through much of the process, Chancellor Merkel and her finance minister Wolfgang Schäuble pushed for a de facto Grexit. The subtext was that if the terms of the deal would be very harsh, Greece would reject them and “choose” exit. But the assumption proved flawed.

In Southern Europe, the larger economies – France, Italy and Spain – opted for a more conciliatory stance; they have their own “Greek-like” debt challenges and remain concerned about punishing austerity measures.

The member states of Eastern Europe took the toughest stance toward Greece. They see the terms as far too soft. Since these countries had struggled so hard to join the Eurozone, they regard Brussels as too soft.

Bailing Out Banks, Not People

Before the deal, European equity markets were down, with the depreciation of the euro and widening spreads in the Eurozone periphery. As a result, calls became more vocal in Washington, Beijing and Moscow call for Athens and its creditors to seek a compromise that would allow Greece to remain in the Eurozone.

Following the deal, equity markets enjoyed a mild rally, with the strengthening of the euro and narrowing spreads in the regional periphery. Optimists saw it as the return of economic certainty and market stability.

But the realities are very different. After the global crisis of 2008, Greek per capita income, adjusted to inflation, has plunged by a third. Let’s put that in context. In 2000, the Greek per capita income was still 17% higher than in South Korea and almost twice as high as in Poland. Today, it is less than $26,000, or 40% lower than in South Korea and about the same as in Poland.

Has the fall of Greek living standards helped to resolve its debt challenges? No. Instead, it has made the debt load a lot heavier. Athens returned to markets only after two huge bailouts of €73 billion and €164 billion, respectively. Meanwhile, unemployment continues to hover around 25% and youth unemployment exceeds 50%. Moreover, Greek public debt almost doubled to €323 billion, or 175% of the GDP. Based on current and benign scenarios, this debt could decline to around 130% in the early 2020s – that is about the same as Italy’s current level, which is considered excessive.

Brussels has vowed that each new bailout would be the last one. But as I have argued since spring 2010, each package has been misguided. All have contributed to the Eurozone sovereign debt challenges. And none have really benefited ordinary Greeks. Indeed, almost 90% of the two bailout monies in Greece have been used to rescue major European private banks, especially in Germany and France. Only 11% of the monies have been directed to Greek people.

The question is whether the third bailout package will prove any different.

The Cul-de-sac of Germanic Europe

Will the deal work? Success would require strong and sustained growth. Yet, during the current year, contraction is likely to exceed 3% in Greece and the return to growth is likely to take until 2017. Thereafter real GDP growth of more than 2% is possible but not sufficient for Athens’s creditors.

Recently, Greece’s Q2 GDP performance of 0.8% surprised markets. But was it a sign of a turnaround? No, the data can be attributed to less fiscal austerity during the talks, pickup in tourism and measurement errors.

Is higher-than-expected growth possible? In theory, yes, but thriving Greek exports would require stronger global growth prospects, which seem unlikely and higher-than-expected Eurozone growth, which seems debatable. Under the bailout terms, recovery will not be rapid and inflation will not support fiscal consolidation.

Are worse-than-expected scenarios possible? Yes, although – despite their aggressive public rhetoric – both troika and Brussels will act cautiously since exit scenarios could prove very costly and potentially catastrophic.

What else could go wrong? The debt negotiations could deteriorate, which would impair nascent business and consumer confidence in Greece. Also, Athens might be unable to pay on wages and pensions, which would worsen devastating social crises in Greece and increase economic uncertainty and market volatility in the Eurozone.

The reform measures of the proposed deal will require further pension reforms, tax reforms to boost revenue and major reduction of military spending. In the coming months, other measures will include an overhaul of the welfare system, agricultural reforms, privatization of electricity transmission and governance reforms of the Greek administration. These changes will not occur without substantial resistance.

Despite popular support, Tsipras is likely to lose a Syriza faction – the so-called Left Platform that calls for Greece to leave the euro – and key members of its right-wing coalition partner Anel. The third bailout can be passed only with the majority of the Syriza-led coalition, and its opposition; the conservative New Democracy, social-democratic PASOK and centrist Potami.

If Tsipras can keep his majority, despite Syriza dissenters, and pass the reforms (and if Merkel can do the same in Germany, despite the rebels of the conservative/social-democratic coalition), Greece will have access to funds. However, as Syriza will hold its extraordinary congress, divisions may well pave way to an early fall election.

Nor will risks disappear from the region. The European project itself seems to have shifted. In the past, Brussels offered regional integration with sovereign flexibility. Guided by the Merkel-Schäuble stance, it is now providing tighter integration but at the expense of national flexibility. This approach reflects German interests, but not those of the Eurozone as a whole.

As a result, it tends to generate highly asymmetric outcomes among countries within the region. For instance, as unemployment rates have soared across the Eurozone, they have fallen in Germany. Other economic data indicate similar discrepancies, as former Fed chair Ben Bernanke and other critics have stressed.

These patterns imply serious medium-term challenges for the Eurozone and will foster division, certainly not solidarity, among the member states.

In the short-term, this approach may work because the alternatives – Grexit, Eurozone fragmentation, increasing volatility – are perceived as prohibitive. In the medium-term it is not likely to survive, politically or economically.

A Pyrrhic Victory

Ever since the onset of the Eurozone debt crisis in spring 2010, those political interests – nationalist movements, Euroskeptics, anti-eurozone parties, extremist fringes – that have historically promoted greater national role within (or without) the European project have been gaining in national and pan-European elections. Over time Germany may either have to accept greater flexibility within greater integration or the Eurozone project will fragment or dissolve.

Assuming that, in the short-term, Brussels will continue to insist on stringent austerity, growth will remain subdued and unemployment high in southern Europe, while fiscally conservative North will no longer be immune to erosion. With such fiscal policies, Eurozone is not economically sustainable.

As the ECB will continue to inject new rounds of quantitative easing (QE), a semblance of stability can be maintained in the near-term. However, the exchange rate illustrates more substantial shifts behind the façade. Between 2008 and 2015 – after rate cuts and rounds of QE, the euro against the U.S. dollar has fallen from a high of $1.60 to $1.12 today. Current policies are likely to drive the exchange rate to parity, or beyond.

The third bailout is likely to result in lingering growth, further decline of living standards, continued unemployment, and diminished future prospects in Greece. Nor will it foster economic certainty or market stability in the Eurozone.

It is a Pyrrhic victory for Brussels. As Greece’s creditors won a battle, they may have lost the war.

This article appeared at European Financial Review and is reprinted with permission.

Dan Steinbock

Dr Dan Steinbock is an recognized expert of the multipolar world. He focuses on international business, international relations, investment and risk among the leading advanced and large emerging economies. He is a Senior ASLA-Fulbright Scholar (New York University and Columbia Business School). Dr Dan Steinbock is an internationally recognized expert of the multipolar world. He focuses on international business, international relations, investment and risk among the major advanced economies (G7) and large emerging economies (BRICS and beyond). Altogether, he monitors 40 major world economies and 12 strategic nations. In addition to his advisory activities, he is affiliated with India China and America Institute (USA), Shanghai Institutes for International Studies (China) and EU Center (Singapore). As a Fulbright scholar, he also cooperates with NYU, Columbia University and Harvard Business School. He has consulted for international organizations, government agencies, financial institutions, MNCs, industry associations, chambers of commerce, and NGOs. He serves on media advisory boards (Fortune, Bloomberg BusinessWeek, McKinsey).

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