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Global Perspectives

Luigi Zingales: The Greek Tragedy, Act II

Published on Mar 20, 2012 11:29 AM

CHICAGO - A Greek tragedy is typically composed of three acts. The first sets the scene. It is only with the second that the plot reaches its climax. For current-day Greece, the imposition of 'voluntary' losses on the country's private creditors represents just the end of the beginning. The real tragedy has still to unfold.

On the face of it, the 'voluntary' arrangement with creditors might appear to have been a big success. The volume of Greece's foreign debt has been reduced by more than 100 billion Euro dollars (S$167 billion). Greece's European partners have provided 130 billion Euro dollars in new loans. As a result, Greece has avoided generalised bank failures, and it has been able to continue paying its public employees.

But, despite these trumpeted results, the reality is much harsher. Even with the latest deal, Greece's debt ratio remains at 120 per cent of last year's GDP. With a projected drop in GDP of 7 per cent this year and a sustained deficit, the debt ratio would exceed 130 per cent before stabilising at 120 per cent in 2020.

But even this reduced level is not sustainable. With its population set to contract by 0.5 per cent annually over the next 30 years, even if per capita income in Greece were to rise at the German rate of 1.5 per cent per year, the debt would be difficult to service. Assuming that Greece could borrow at a real interest rate of only 3 per cent (the current level is 17 per cent), the government would need to run an annual 2.6 per cent-of-GDP primary budget surplus (the fiscal balance minus debt-service costs) for the next 30 years just to keep the debt burden stable.

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