Greek PM: Two Deals But No Drachma Ahead
In his first and only interview since taking office, Greek Prime Minister Lucas Papademos took straight aim at those who suggest Greece should abandon the euro and return to the drachma as a way to solve the country’s fiscal crisis: “This is really not an option.”
Papademos also expressed complete confidence in his country’s ability to get through what is likely to be a harrowing two months as it approaches a 14.5 billion euro debt repayment in March. (Click here for full interview transcript.)
Two different financial deals must be negotiated before then. Without both, his country is likely to default—which would make it the first in the euro zone to do so, not to mention the largest sovereign default in history.
Greece is at the epicenter of the European financial crisis and how Papademos handles the situation is being closely watched by market participants around the world.
Failure on his part and on the part of the Greek government to manage their debt crisis is an orderly way, would have economic consequences across the European Union.
But Papademos is unperturbed. And he thinks the country is well on the way to avoiding a March default.
“Our objective is to complete the two processes and also to fulfill our commitments that have been made in the past … and we are confident that we’re going to achieve this.”
The first of the two deals is with the country’s private sector lenders—banks, pension funds, and hedge funds around the world that own 206 billion euros worth of Greek government debt. At the behest of the International Monetary Fundand the European Union, Greece must reach a deal with those private sector creditors, convincing them to accept only half the amount of money they are owed; a 50 percent “haircut,” a term used in the bond market when a borrower can’t pay back in full.
The IMF and the EU have imposed this condition in order for Greece to secure a second bailout of 130 billion euros worth of low-interest loans. These institutions, funded by tax payers, do not want to be Greece’s lender of last resort without first seeing the banks contribute to a reduction in Greece’s debt.
The talks between Greece and the private sector hit a snag on Friday when one of the negotiators, the Institute for International Finance, announced a “pause for reflection.”
But in his interview with CNBC, Papademos brushed off the delay, saying “over the past few weeks, substantial progress has been made towards reaching an agreement between creditors and Greece,” and that they are “close to an agreement.”
“But some further reflection is necessary on how to put all the elements together. So as you know, there is a little pause in these discussions. But I’m confident that they will continue and we will reach an agreement that is mutually acceptable in time.”
Papademos declined to say exactly what the hold up is. But several sources close to the deal tell CNBC that snag is related to how much interest Greece should pay on new debt it issues to replace old debt.
Thus far, the plan is to offer current bondholders 15 cents in cash equivalents and 35 cents in new debt for every 100 cents of debt they hold. The maturity on that new debt is likely to be 30 years.
Financial institutions wanted an interest rate of as high as 8 percent on the new debt. But the IMF and some members of the EU wanted it to be as low as 2 percent. The official sector’s rationale: The easier the repayment terms are for Greece, the less likely their taxpayer-funded institutions are on the hook for future money.
However, the dilemma Greece and Europe both face, is that if the offer is too low, very few bondholders will accept it, pushing Greece into a default after all.
If and when the deal with the private sector gets done—Greece must then come up with a 4-year economic plan that is acceptable to the IMF and the EU, in order to secure the 130 billion euros and fund its operations. That deal with the IMF and the EU must also get done before the March repayment deadline.
As for keeping the Euro as its main currency, Papademos says there is 100 percent political will to do all that takes to ensure it. “This is the position of this government and of all the parties that are supporting it, and what is more important, the overwhelming majority of the Greek people are in favor of Euro area membership.”
Very few doubt Greece’s desire to stick with the euro. What is likely to be far more contested by market participants is Papademos' steadfast belief that staying with the euro actually helps Greece regain competitiveness, rather than hinders it.
Drachma is no cure? ...
“Some people think otherwise. But I think this is clearly not the case,” he said.
Indeed, his view runs counter to what is increasingly economic consensus: By abandoning the Euro, and replacing it with its own currency, Greece could go through a dramatic devaluation. This would make the country’s labor, services, and exports much cheaper in the world markets and thus more competitive. This, many believe, would be a faster road to economic recovery and growth.
But Papademos' take? Been there, done that.
“In the 20 years before Greece ended up with the Euro, efforts to improve competitiveness through exchange rate adjustments resulted only in temporary gains in competitiveness. And they were accompanied by very high inflation and low growth performance.
As a result, the economic policies pursued were not sufficiently disciplined, and did not foster the fundamental restructuring the economy needed in order to foster growth. So our own experience suggests that this (abandoning the euro) is really not an option.”
“I am personally convinced—and I think the Greek people share this belief in a fundamental way—that we can achieve fiscal consolidation more effectively and we can restore competitiveness in a more fundamental and permanent way within the euro area than outside.”
Papademos’ understanding and embrace of market discipline makes him an unlikely prime minister. He is a central banker by trade, not a politician—having once run the central bank of Greece and serving at the European Central Bankunder Jean Claude Trichet. He was not elected to his current post but was asked to serve at a moment of crisis last November because country was desperate for that very experience. (Read Papademos' views on the ECB here)
His style is classic central banker: always unruffled, at times monotone, with a precision in his self-expression that comes from a deep economic vocabulary.
That doesn’t mean he isn’t aware of the staggering social consequences that come with the process of cutting Greece’s massive spending levels, and reforming the economy. Greek GDP is set to fall for a fifth straight year (a decline of more than 15 percent from top to bottom) and unemployment is above 18 percent. Papademos says “clearly the process involves pain,” but he believes the “effects are temporary.”
He needs both his country men, and the markets, to believe that. The decline in Greece’s economy has been so great, many are starting to question whether a 50 percent haircut on private sector debt, and another 130 billion euros in loans from his EU partners will even be enough.
Papademos rejects the notion, saying “this will not be necessary” based on what he knows about the economy and the adjustment program they need to undertake. “I think the funds that have been pledged at Euro Summit, combined with the outcome of the private sector involvement process should be sufficient in order to support financially the Greek economy.”
And although he doesn’t say it out loud, it’s clear that since he is not concerned about being reelected, he feels far more free to focus on what he believes are lasting solutions and to stand up to vested interests trying to hold up reform.
“I think the gains to be achieved by a combination of reforms and labor market adjustments are going to be more permanent and will provide a basis for reducing unemployment and improving export performance, and sustaining growth, in a way that is more sound and more permanent,” he said.
He, like nearly all economists, believes the true solution is for Greece’s economy to grow again. For Greece to grow, it must regain competitiveness. Papademos says key steps have already be taken on that front and more are to come. Since efforts began two years, Papademos says “measures of competitiveness, based on unit labor costs show that we have gained competitiveness by about 5 percent.”
He estimates that with further reforms, by the end of 2012, “we should recover about one half and possibly three-fifths of that competitiveness loss over the previous nine years. So the process has adverse effects in the short, but it is working.”
He points to major pension reform that has changed what was once the most vulnerable pension system in Europe to one that is sustainable long-term. “This has implications not only for public finances. It also has implications about the way the markets think with regard to the overall fiscal (situation) and environment within which the economy will operate in the future.”
Slowly but surely, he says, they are stripping regulations from the books that make it tough to establish a business or invest in Greece. Just last week, he says, his cabinet approved a bill that he believes will increase exports and smooth the functioning of business.
Equally essential, he says, are the steps they are taking to improving the efficiency of the legal system. “Delays in the granting of justice very often reduce the speed with which investment could be undertaken, discouraging investors.” Steps include prioritizing certain cases rather than giving every case, regardless of the matter at hand, equal weight.
Greece has reduced the size of the public sector and Papademos says it will get even smaller: a reduction of 110,000-120,000 government workers in the last two years, out of an estimated 800,000. This has been done through attrition by not renewing contracts or replacing retirees. In the future, he says entire departments will be eliminated, though this is one of the toughest measures of all to achieve. In Greece, it is a violation of the constitution to fire a permanent government worker.
The labor market is where the hurdles to reform were highest and, he acknowledges, an area where even more progress has to be made toward liberalization. “There were many restrictions in these markets that prevented competition, implying also that prices were kept at relatively high levels. Through legislation that was enacted last year, quite a few professions have been liberalized.” What didn’t get done last year he says, will get done this year.
These are by far the most unpopular measures. Many professions previously had guaranteed wages and price structures, with employers having little say over how much they could pay their workers. Massive protests erupted in September when a law was passed suspending union-dictated salaries. And just this week, the nation's lawyers went on strike, angry that they too will face liberalization and more competition.
Despite the visibility of protests in the past, Papademos believes the Greek people are with him when it comes to making tough changes.
“I am convinced that the public, the large majority of the Greek people, realize that the policies pursued in the past and the market practices have to be changed, in order to improve the prospects of the Greek economy. So there is, I think, strong public support, despite the increases in social tensions.”