On Sunday, Greek voters decisively rejected a proposal from the nation's creditors to swap new refinancing of Greece's 342.5 billion euro in debt in exchange for tax increases and deep cuts in public spending, especially on pensions. With the unemployment rate stuck near 26 percent and the economy sinking deeper into a depression that has already cut gross domestic product by 30 percent since 2010, Greeks decided not to bet on the idea that more austerity would return their country to prosperity.
Nonetheless, Greece missed a 1.6 billion euro payment on its debt last week and remains "in arrears,'' according to the International Monetary Fund, which, along with the European Central Bank and European Commission, represents Greece's creditors. Nearly all of Greece's debt is held by official creditors, who bought up most of the holdings of hedge funds and other private investors years ago. Until the default is fixed, the IMF says, it won't lend Greece more money.
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With the nation once again running a budget deficit after briefly achieving a so-called primary surplus—meaning, a surplus before interest payments—Greece clearly needs more money soon. Here are some of the key questions and answers about what's going on—and what might happen next.
What do the creditors want?
Going into the election, their proposal was to cut pensions by another $2.5 billion or more and to raise taxes, especially value-added taxes on tourism to the Greek islands. Since tourism generates almost one-fifth of Greece's GDP and is the nation's only industry besides petroleum refining that generates as much as $2 billion a year in exports, a proposal to boost the VAT on island tourism to 23 percent from 9 percent was a tough sell.
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Creditors' proposals also included selling off publicly owned airports and electricity transmission and cutting military spending, as well as raising corporate income taxes and cutting tax subsidies for diesel fuel and heating oil. The creditors have little else to work with: IMF research director Olivier Blanchard wrote June 14 that pensions and salaries for government workers are 75 percent of the remaining Greek government budget, since everything else has already been "cut to the bone." Pensions alone eat up 16 percent of Greek GDP—almost as much as tourism brings in.
By contrast, in the U.S. the old-age and survivors insurance program within Social Security costs less than 5 percent of gross domestic product. Even a 25 percent cut in Social Security benefits would reduce U.S. growth by 1.5 percentage points in the first year, according to an analysis by the American Association of Retired Persons.
How has earlier austerity affected Greece?
The nation has cut spending by 30 percent since 2008 in response to creditor demands, and GDP has dropped from a high of $355 billion in 2009 to $238 billion last year—about 33 percent—according to Trading Economics. The U.S.boosted spending during the recession and has cut since, with spending now slightly lower than in early 2008, Trading Economics claims.
The moves were enough to put Greece briefly into a surplus in 2013. Creditors had expected the austerity measures in a 2012 deal to push Greece's surplus to 4.5 percent of GDP by next year. But the chaos in Greece's economy has driven down the amount expected to be received from privatizing government assets, including those held by banks, and tax collection has remained abysmal.
There's little chance Greece can repay its full debt, and basically no chance that it can run its government without access to credit, so more talks to try to find a deal are forthcoming. Greece's finance minister, Yanis Varoufakis, who has had a contentious relationship with creditors, resigned after the election in an apparent attempt to pave the way for more negotiations.
In a report last week, the IMF conceded that it's likely the international creditors will have to "take a haircut" by reducing the principal amount of the debt they hold so Greece can make its payments. How much? In 2012, hedge funds agreed to write down about 70 percent of their remaining debt, setting one potential parameter. The IMF's report floated the idea of writing down the debt by about 53 billion euro, which would make the rest of the debt sustainable if Greece's economy grew 1 percent a year and the government ran consistent surpluses of 2.5 percent of GDP.
What's the best that can happen?
The best-case scenario could take either of two forms, depending on whether a deal is reached. The path the parties will try first is to make a deal, but that would require Germany to back off its opposition to reducing the principal amount of Greece's debt. On Monday, Greece's creditors said the ball was in Athens' court to present a credible deal.
With a deal, Greece makes some cuts that are largely offset by a reduction in the payments it has to make to its creditors, whether for interest or for principal reduction. This wouldn't be likely to deliver actual prosperity soon, but might prevent the situation from worsening.
The best-case scenario for Greece without a deal is that it follows the path Argentina did in 2001 and 2002: Devalue its currency, which in Greece's case means abandoning the euro in favor of its own money, hoping that the drop in the cost of tourism and other Greek exports draws enough customers to begin delivering prosperity in a year or two. However, Varoufakis dismissed this idea in a May blog post, saying, "Greece cannot pull off an Argentina.''
What's the worst that can happen?
There's little chance that Greece's fundamental economic problems will have much effect on either the U.S. or the rest of Europe, Moody's Analytics chief economist Mark Zandi said last week.
Moody's doesn't think that any financial contagion from a Greek default will force any run on the debt of other struggling euro zone economies, like Spain or Italy, and indeed, yields on their 10-year bonds stayed stable last week amid Greece's uncertainty.
Within Greece, however, the short term looks very difficult in any scenario. Any deal is likely to raise taxes and cut spending to some degree, hampering an already shrinking economy. If Greece leaves the European currency union, whatever currency it issues is likely to be sharply devalued. If Varoufakis is right, the rest of Europe wouldn't generate enough tourism or shipping revenue to make up for the value of savings lost in the devaluation, and Greece's human suffering would intensify.
Bottom line: No one will be really happy with whatever outcome emerges.
"These are tough choices, and tough commitments to be made on both sides," Blanchard wrote on his blog.