Meanwhile, in Greece…

Austerity measures proposed. Is it enough? Well…
Greece signs up to €24bn austerity package
Carl Mortished, Susan Thompson

The Greek Government has agreed the draft outline of a €24 billion (£21 billion) rescue package, which is expected to include savage cuts in civil service wages and state benefits along with hefty tax increases to cut its budget deficit.

Final details of the measures were still being hammered out last night with officials from the IMF, the European Commission, and the European Central Bank. A final draft should be presented for approval by the Greek parliament next week.

Any deal, however, could still be derailed by continuing political infighting in Germany, where opponents of Angela Merkel’s Government threatened to oppose a Bill authorising Germany’s participation in an austerity package of rescue aid.

George Papandreou, the Prime Minister, said that he expected the aid to be agreed within days but gave warning that Greece faced a battle for survival.

“We will do whatever it takes to save the country,” he said.

The Moody’s ratings agency again said that a multi-notch downgrade of Greece was likely. It will conduct a review after the EU/International Monetary Fund rescue package is announced. Standard & Poor’s downgraded Greece to “junk” status on Tuesday.

In Germany, opponents of the bailout continued to harass Mrs Merkel’s coalition Government, calling for banks to participate in the rescue.

The proposal by the opposition Socialists that banks and investors in Greek bonds should accept less than full repayment threatens to scupper a vote planned for next week on a Bill that would allow Germany to join the three-year aid programme.

Norbert Barthle, a budget spokesman for the ruling Christian Democrats, said that he was in favour of private sector participation in the bailout.

Officials from the International Monetary Fund and the European Central Bank were in Athens yesterday attempting to bully and cajole the Government into agreeing a three-year austerity package that would bring the colossal gap between Greek government spending and revenue to manageable size.

Hopes that the eurozone leaders were close to a deal boosted the euro on the foreign exchange markets. It gained more than a cent against the dollar to $1.3357, shedding losses earlier in the week when fears of a Greek sovereign default sent the single currency to a one-year low.

The Greek stock market gained 7 per cent and the risk premium on Greece’s ten-year bond compared with the German bund narrowed slightly but remained high at 7.9 percentage points. The IMF and ECB are reported to be seeking spending cuts of €25 billion over two years.

The axe likely to fall on civil service wages and benefits, including the abolition of the 13th and 14th month salary. Scrapping the extra two months’ salary, traditionally paid as a Christmas and Easter bonus, would amount to a 14 per cent wage cut and could save more than €1 billion.

An increase in VAT of between 2 and 4 percentage points is also being considered, as well as steep hikes in fuel, tobacco and alcohol taxes.

As the European Commission held out hope of an imminent rescue deal, evidence emerged of further damage to Greece’s financial sector with figures from its central bank showing that depositors had withdrawn €10.6 billion from the nation’s banks in the first quarter of the year. The figures show the capital flight, which began in January, continued into March, a 4.5 per cent drop in bank deposits for the first quarter.

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Some observations:

  • Let the enormity of it all sink in: a 14% wage cut for public sector workers amounts to just 1B of the 25B euro package
  • What such a package will do to the economy is not difficult to gauge
  • Germany wants

Here is what Olivier Blanchard (head of the IMF) said a week ago:

  • IMF chief economist Olivier Blanchard remarked that “new, and no less formidable, challenges” have already begun to surface.” He said fiscal consolidation has to be a priority for advanced economies that are suffering from debt, but that this would likely put pressure on demand, and thus hinder economic growth.

Indeed. Ireland embarked on such program last year. The results are not encouraging: economic growth in 2009 was, well, terrible, the economy is still in recession and the budget deficit, despite all the cuts and tax hikes, is still at the same 11% of GDP as it was last year. And despite all these tough measures, bond yields went up sharply through the ‘Greek contagion.’ So even taking the necessary measures doesn’t provide much shield (although we readily admit, without these measures the damage would have been much greater).

If you want to know more on the Irish economy, there is a pretty good blog dedicated to that.

It’s always nice to check what Krugman is saying. He mentioned a Barry Eichenhorn argument which amounts to saying that leaving the euro takes time and would invite bankruns. Krugman turns that around. If bankruns happen anyway (and Greeks are withdrawing from their banks as we speak), the cost of leaving the euro fall drastically…