A Look at Greece's Familiar-Looking Aid Proposal
Fundamental Forecast for Euro: Neutral
- Euro traded broadly higher after Greece delivered meaningful aid proposal.
- Greek proposal close to creditors' proposal from late-June.
- In sum, aid proposal mirrors those agreed upon since 2010.
EURUSD rallied into $1.1200 by the end of the week, continuing its reaction to Greece’s proposal to creditors for new assistance. On the surface, there are few major differences between the current Greek proposal and what was outlined by the Eurogroup at the end of June. We’ve ranked the categories in descending order from “most agreement between the Greek proposal and the creditor proposal” to the “least agreement between the Greek proposal and the creditors’ proposal”:
- Privatizations: The Greek proposal fully accepts all of the creditors’ demands re: asset sales. The government will sell regional airports as planned (due to an agreement from the prior government) and it will transfer the state’s shares in a utility company to the asset sales fund.
- Tax reform: The Greek proposal accepts nearly all of the creditors’ demands re: changes in tax structure. The only differences are: (1) sales tax discounts on islands will be eliminated gradually by the end of 2016, instead of starting right away as the creditors’ proposal asked for; (2) hotels will be taxed at 13% as opposed to the standard 23% rate.
- Pensions: The Greek proposal agrees with the creditors’ demand to eliminate early retirement benefits, and there are few differences elsewhere. The “zero deficit” clause would be implemented in October as opposed to immediately as proposed by creditors. Also, the Greek proposal seeks to begin phasing out supplementary allowance for low pension by the end of 2019, as opposed to immediately as requested in the creditors’ proposal.
- Length of debt financing: Indeed, the Greek government’s proposal would clear the air of financing issues for three years as opposed to the original creditor proposal of five months. At the heart of the matter, however, the fiscal targets remain the same: primary budget surpluses are due at 1%, 2%, 3%, and 3.5% of GDP between 2015 and 2018. Basically, the only difference in the proposal then is not what it is trying to achieve (the budget surpluses), but the path it is taking there (one large program covering three years as opposed to several incremental programs, with the first expiring in five months). ‘Six of one, half a dozen’ type of situation – all sums to the same thing if the policies are enacted and embraced successfully.
- Structural measures: The Greek proposal varies slightly from the creditors’ proposal, though not in content but rather by the timing of implementation. Greece wants to increase advanced income tax payment on corporate tax to 100% and gradually for small businesses by the end of 2017, as well as eliminating preferential tax treatment for farmers by the end of 2017; creditors want these efforts to be undertaken by the end of 2016. One major difference is in military spending: the Greek government proposed reducing spending by €100 million in 2015 and €200 million 2016; the creditor proposal wanted €400 million right away.
- Debt restructuring: This is a Greek proposal, not a creditor one, and is not necessarily a lock to happen. While the US, the IMF, the European Council, and a number of individual Euro-Zone countries have admitted that debt relief is necessary to help fix the situation, German policymakers have steadfastly rebuffed any proposal that’s included debt restructuring. German Chancellor Angela Merkel has said that a “classic haircut” is out of the question. What has happened in the past for Greece (back in 2012) is a debt reprofiling, whereby the bonds’ maturities are extended and their interest rates are reduced. However, this clearly isn’t a viable solution; if it was, we wouldn’t be having this discussion we are today.
- Labor Reform: Creditors don’t want changes to the previously agreed upon labor framework and insist that any changes be negotiated with the EU, ECB, and IMF. The Greek proposal intendeds to legislate on changes to collective bargaining agreements by the end of 2015 without consulting the three creditor institutions.
There are a lot of similarities in the proposals, the main differences being the timing of implementations. Understandably, the Greek proposal is more lenient on the pace of reform (which fits with their electoral message of ‘austerity is choking off growth’). Nevertheless, another bailout program for Greece – this deal looks like a variation of what has been implemented since 2010 – won’t solve the catalyst to the crisis.
Why Have Euro-Zone Fiscal Issues Persisted?
The heart of the issue in the Euro-Zone right now is that there isn’t a ‘federal level’ fiscal transfers system as constructed in the United States; the Euro-Zone isn’t a fiscal union. In the United States, when a state runs a deficit (like Mississippi or West Virginia), there is an automatic rebalancing with excess funds collected from surplus states (like New York or Minnesota). This is useful for situations like rising unemployment, when the government has to make additional outlays for things like unemployment benefits. The net-effect is a more integrated economy across states, with more homogenous rates of growth and inflation.
On the other hand, in the Euro-Zone, these automatic stabilizers don’t exist. When a deficit country (like Greece) goes into a crisis, it must make political concessions to surplus countries (like Germany) in order to receive aid funds. This makes for a contentious process, ultimately creating an imbalance of power skewed towards the surplus countries. We’re seeing this now, with Germany essentially holding all the chips at Greece’s expense.
While a fiscal union is still further down the road (if at all, ever; Germany doesn’t like the idea in the very near-term), the current proposals set forth by Greece and the creditors’ should have enough common ground that an agreement can be reached before the negotiation deadline on Sunday, and the (now) €4.2 billion repayment due to the ECB on July 20.
Over the long-term, without a fiscal union in place (or efforts to move towards that integration), these types of budget crises are bound to come up in the future given the heterogeneity of economies across the Euro-Zone. Any solution given to Greece in the short-term would be like bringing a car to the mechanic and only getting the fluids and tires changed when in reality the entire transmission needs to replaced. Germany may have to compromise on a few of its fiscal ideologies if the notion of European integration is to move past the current crisis and survive in the future.
--- Written by Christopher Vecchio, Currency Strategist
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