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July 13, 2015 at 12:14 PM
The deal announced Monday morning has averted, at least for now, Greece’s immediate exit from the euro zone — an outcome that no European leader was yet willing to press to its increasingly logical conclusion. Greece undertook important policy commitments in return for about $100 billion in incremental external financing. But the agreement doesn’t provide yet the type of debt relief the country desperately needs.
The negotiations over the weekend were bruising and messy, and came very close to an ugly derailment several times. Implementation will be equally difficult and uncertain — and not only because of the economic and financial challenges. The institutional, political and social aspects are equally thorny.
Reflecting the sad recent history of Greece’s relationship with Europe, which have eroded trust and mutual respect, the deal imposes intrusive monitoring and micromanagement by European institutions and the International Monetary Fund. And the conditions aren’t limited to a long list of steps that must be taken before any money is released and what are likely to be frequent on-the-ground policy reviews. The Greek government also has to set up a special fund to receive state assets and the proceeds of privatization to spend on activities that creditors deem important — including paying down debt and recapitalizing banks — and that require their close involvement.
The immediate financial challenges of implementation include reopening banks that have suffered consequential damage to both sides of their balance sheets. On the liabilities side, huge deposit outflows have required enormous dependence on the European Central Bank’s Emergency Liquidity Assistance, which will surely continue to be needed on a large scale in the short- run. The asset side is dominated by a growing stock of nonperforming assets and other dubious holdings (including a huge stock of Greek government bonds), raising serious doubts about the solvency of the banks.
In addition to the immediate recapitalization of its banking system, the government must also secure bridge financing to clear its arrears to the IMF and meet a large upcoming payment to the ECB. And this needs to be done in a manner that acknowledges that Greece’s existing debt stock is already unsustainable.
These tricky steps toward financial normalization are a necessary condition for reversing the economic implosion, but they are far from sufficient. Economic activity also faces headwinds because of the considerable structural damage that has already been inflicted, as well as the additional strain that new taxes will impose. Meanwhile, credible pro-growth structural reform measures haven’t been properly developed; and too little of the external funding is likely to find its way into the economy for uses such as easing the strain on overstretched social safety nets.
