What’s in the Bailout Package for Greece and Will It Work?

Martin Wolf at the Financial Times points out that “Greece is being asked to do what Latin America did in the 1980s. That led to a lost decade, the beneficiaries being foreign creditors.”

Korea had to accept IMF austerity measures during the 1997 financial crisis. Seeing what’s going on in Greece reminds us how beneficial or disadvantageous that program had been to Korea.

From FT:

So what is the programme? In outline, it is a package of €110bn ($143bn) (equivalent to slightly more than a third of Greece’s outstanding debt), €30bn of which will come from the IMF (far more than normally permitted) and the rest from the eurozone. This would be enough to take Greece out of the market, if necessary, for more than two years. In return, Greece has promised a fiscal consolidation of 11 per cent of gross domestic product over three years, on top of the measures taken earlier, with the aim of reaching a 3 per cent deficit by 2014, down from 13.6 per cent in 2009. Government spending measures are to yield savings of 5¼ per cent of GDP over three years: pensions and wages will be reduced, and then frozen for three years, with payment of seasonal bonuses abolished. Tax measures are to yield 4 per cent of GDP. Even so, public debt is forecast to peak at 150 per cent of GDP.

In important respects, the programme is far less unrealistic than its intra-European predecessor. Gone is the fantasy that there would be a mild economic contraction this year, followed by a return to steady growth. The new programme apparently envisages a cumulative decline in GDP of about 8 per cent, though such forecasts are, of course, highly uncertain. Similarly, the old plan was founded on the assumption that Greece could slash its budget deficit to less than 3 per cent of GDP by the end of 2012. The new plan sets 2014 as the target year.

Two other features of what has been decided are noteworthy: first, there is to be no debt restructuring; and, second, the European Central Bank will suspend the minimum credit rating required for the Greek government-backed assets used in its liquidity operations, thereby offering a lifeline to vulnerable Greek banks.

For other eurozone members, the programme prevents an immediate shock to fragile financial systems: it is overtly a rescue of Greece, but covertly a bail-out of banks. But it is far from clear that it will help other members now in the firing line. Investors could well conclude that the scale of the package required for tiny Greece and the overwhelming difficulty of agreeing and ratifying it, particularly in Germany, suggest that further such packages are going to be elusive. Other eurozone members might well end up on their own. None is in as bad a condition as Greece and none has shown the same malfeasance. But several have unsustainable fiscal deficits and rapidly rising debt ratios (see chart). In this, their situation does not differ from that of the UK and US. But they lack the same policy options.

The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.