Europe Backs Greece, but Hurdles Lie Ahead

Posted by: Mark Scott on February 03, 2010

Debt-ridden Greece got a bit of a boost on Feb. 3 when the European Commission approved the country’s plan to bring its budget deficit problems under control. In 2009, Greece logged Europe’s largest deficit, at 12.7% of GDP, but now it aims to lower the figure to just 2.8% by 2012.

To meet the target, the country’s prime minister, George Papandreou, unveiled ambitious belt-tightening plans on Feb. 2, ranging from a freeze in government workers’ pay to tax hikes on gasoline and alcohol.

Though Brussels has given a thumbs up to Greece and its (perhaps optimistic) attempt to rein in spending, the true test will be whether Papandreou can pull off the spending cuts. Financial markets reacted negatively last week to fears about Greek sovereign debt by sending yields on the country’s bonds to an 11-year high vs. their German equivalents—a record 396 basis points. By close of trading on Feb. 3, that spread had fallen to 348 basis points, according to Bloomberg data. Yet with unions calling a strike on Feb. 10 against Papandreou’s proposals, optimism maybe short lived.

The prime minister is adamant that everybody in Greece must buckle down to help cut the country’s deficit. He has called for a $11 billion worth of measures, including pay cuts for government workers and a tax on large properties. In a nationally-televised address on Feb. 2, he said: “Greece is in the center of a speculative game aimed at the euro…It is our national duty to stop the attempts to push our country to the edge of the cliff.”

The southern European country isn't likely to receive help from EU officials. Many are still angry over auditing errors in Greece's national accounts last year that caused its deficit to be understated. When the errors were unearthed, the deficit ratio more than doubled, to 12.7%. Now, the European Union aims to keep a close eye on the country's books, checking them on a regular basis to ensure Greece is staying on track. "Every time we observe slippages, we will ask the Greek authorities to adopt additional measures," EU Economic and Monetary Affairs Commissioner Joaquin Almunia told reporters in Brussels on Feb. 3.

Even if Greece can bring down its deficit and convince its population to embrace austerity, more problems lie ahead. For one thing, the country's economic competitiveness compared to other European and global countries remains woeful. In the latest competitiveness report by the Lausanne, Switzerland-based IMD Business School, Peru, Bulgaria, and even Kazakhstan ranked higher for overall competitiveness than Greece. That's not a good sign as the country tries to turn its economy around.

Worse still, Greece's government debt won't come down quickly, even with Papandreou's new budget. Last year, the ratio of government debt to GDP stood at 113.4%. Greece now projects it will peak at 120.6% in 2011. Budget cuts should help bring the figure down to 113.4% by 2012, but that's still no better than the ratio in 2009. If Papandreou succeeds in pushing through his austerity budget over the objection of the Greeks, his next challenge will be to tackle Greece's long term debt problem.