GREEK CHOICES AFTER THE ELECTIONS

1. Exit is not an option: Greece would enter another deep recession, which would push unemployment up further and reduce budget revenues, requiring another round of harsh fiscal consolidation. Euro-area creditors would lose a lot on their Greek claims and private claims on Greece would also suffer. Moreover, exit would also risk the stopping of EU-budget related inflows to Greece (cohesion and structural funds, agricultural subsidies).

2. Debt write-down is extremely unlikely and unnecessary as well: Any level of debt is sustainable if it has a very low interest rate.  Loans from euro-area partners to Greece carry super-low interest rates and also have very long maturities. Actual interest service costs of Greece will likely be below 2% of GDP in 2015, if Greece meets the conditions of the bail-out programme. Since the actual debt servicing cost of Greece is low, it is extremely unlikely that parliaments and governments of euro-area lending countries would decide to cancel their Greek loans and raise taxes at home to cover the losses.

3. Maturity extension and further cut in interest rate: While euro-area loans to Greece already have extremely long maturities, further extension is possible. Whether the average maturity is 30 years or 40 years, there is not a big difference. Moreover, the 50 basis point spread over Euribor, which is charged on bilateral loans, can be abolished without leading to direct losses to euro-area partners.

4. A new financial assistance programme: A third programme could be put in place to take Greece out of the market until 2030. Even if the currently very high market interest rates for Greece will fall, they will likely remain too high.

5. Easing fiscal policy: The new programme could be accompanied by enhanced budgetary commitments by Greece, whereby Greece would engage to reach a balanced budget by 2018. If the maturities of euro-area loans to Greece are lengthened and the 50 basis points spread on bilateral loans is scrapped, the primary surplus could be reduced by an additional half percent of GDP. Therefore, there would be some room for manoeuvre to ease the social pain and to help growth with some public investment.

6. Structural reforms: Even Syriza argues that Greece needs major structural reforms. Yet it may be difficult to find an agreement between Greece and the Troika, because many of the current plans of the Greek opposition parties are in diametric opposition to reforms agreed under the financial assistance programme. But a compromise has to be found: both sides have strong incentives to agree and structural reforms have to be part of the comprehensive agreement.

9. A European boost to economic growth in the euro-area periphery: There is a need and a strong rationale to support growth throughout the euro-periphery, but unfortunately little political reality.

10. European assurance for Greece against adverse shocks: Even if Greece will cooperate with euro-area partners and will fulfil its commitments, such a high debt ratio is sensitive to adverse risks, like weaker growth, lower inflation or higher interest rates. Therefore, some sort of European assurance is needed for Greece to eliminate the uncertainty over Greek debt, if Greece meets loan conditions. Otherwise, the uncertainty may deter the investment climate, even if euro-area loans have super-long maturity and low interest rates. One option would be to index official loans to Greek GDP . Thereby, if the economy deteriorates further, there will not be a need for new arrangements, but if growth is better than expected, official creditors will also benefit. Another option would be to commit on the part of lenders to reduce loan charges below their borrowing costs, should public debt levels prove unsustainable despite Greece meeting the loan conditions .

Scenario

1. There is a lack of an agreement which may lead to Grexit. This would be so bad for all that both the new Greek leadership and euro-area partners have very strong incentives to avoid it.

2. There are some reasonable options to agree on the reduction of the debt burden and easing fiscal policies. Thereby, the new Greek leadership could claim that it achieved a major reduction in the cost of debt service and got some fiscal space to ease the social pain and boost growth, while European partners could tell their people that they only extended the loan maturities and eliminated the gap between their own borrowing costs and their lending rate to Greece, thereby taxpayers should not suffer loss.

3. When a government is formed, negotiations could be suspended, perhaps repeatedly, which would create further uncertainty. Such uncertainty would lead to deposit withdrawal from Greek banks and deteriorating economic and fiscal outlook. Some euro-area partners may say no to certain parts of the agreement even if other euro-area partners agree. Some members of the new Greek parliament may say no even if the new government and most of its parliamentary members are in support.

Greek Interest Burden on Public Debt in 2014

• Greek Gross Public Debt= 175% of GDP
• Interest Expenditure= 4.3% of GDP
• Interest Expenditure, excluding interest paid to ECB/NCBs and deferred interest payments to EFSF= 2.6% of GDP