European policymakers – and financial markets – need to take heed of worsening political and economic developments in Greece.
Among the more disturbing developments is the country’s apparent loss of political willingness to comply with the terms of its international financial support programme after four painful years of budget austerity.
Negotiations with the International Monetary Fund (IMF) and the European Union on reviewing the programme, which should have been completed last September, show no signs of being concluded anytime soon. This could cause real difficulties for Greece by May 2014 when large loan repayments to the European Central Bank come due.
The Greek government insists that, in view of the sharp rise in unemployment and fall in output, it simply does not have the political support to take further painful budget or reform measures. With the country now enjoying a small budget surplus, excluding interest payments, the government believes that it can take a tough line in EU-IMF negotiations.
The IMF and EU are insisting that, after years of policy disappointment, Greece must fulfil unkept promises to reduce the public sector and accelerate privatisation. They insist that Greece must close an unfunded 2014 budget gap estimated at around €1.5bn. A ruling by Greece’s highest court that earlier wage cuts for the military and security forces were unconstitutional, and have to be rolled back, will add to the unfunded budget gap.
Reluctance to implement further painful reforms is hardly surprising given the deterioration of Greece’s political climate. Depleted by defections, the coalition government’s majority in the 300-member parliament has now fallen to three.
There are doubts about how long the government headed by New Democracy leader Antonis Samaras can survive. Clear divisions have opened up in Pasok, the junior coalition partner. The far-left Syriza party, comfortably leading in the polls, is making the combined May European parliamentary elections and local elections into a referendum on the government.
"Facing strong fiscal headwinds, the Greek economy is unlikely to recover meaningfully this year." Should the government fare badly in May, as appears likely, early general elections may ensue. Were Syriza to win, Greece’s place in the euro would again be at risk, especially if Syriza, once in government, stuck to its plan of tearing up the IMF-EU memorandum of understanding.
Facing strong fiscal headwinds, the Greek economy is unlikely to recover meaningfully this year. This will contribute further to political fragmentation in 2014. This would appear to be particularly the case now that the Greek economy is succumbing to outright price deflation.
Given the lack of real progress in reforming the Greek economy, European policy-makers might baulk at providing the country with further financial assistance that would be highly unpopular with their domestic electorates. European policy-makers are right in thinking that Europe is in a much better position now to weather another major Greek crisis than it was in 2010. However, risks of contagion to the rest of the periphery would remain. Any hint that Greece might again consider leaving the euro would have major reverberations.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the IMF’s Policy Development and Review Department and chief emerging market economic strategist at Salomon Smith Barney.