Syriza came into power with the promise to end the policy of “extend and pretend”. One interpretation of it was that when the existing programme was to come to an end, no new one would be requested. That covers the “no extend” part. However, the “no pretend” part meant that the financial commitments within the existing programme would be honoured by the creditors while the fiscal and regulatory measures that the Greek state was supposed to undertake under the programme would not. Initially, in February and March of this year, it was agreed that the Greek government would submit the list of alternative measures, reflecting their electoral mandate, that it intended to implement, but those never came in sufficiently clear form. So, the existing programme could not be concluded and the loans coming due could not be repaid, starting with the one owed to the IMF.
No extension of new credit, and no pretence of repayment
In the interim, extension of the credit line from the European Stability Mechanism (ESM), the bail-out fund of the EU, became necessary if the existing debt was to be repaid because of the deteriorating economic and fiscal situation in Greece. Now, “no extend” meant that the new credit will not be requested while “no pretend” meant that the outstanding debts should be largely written off as those have become unsustainable. Of course, the remaining funds from the previous bail-out programme, now already expired, were still needed to pay back the debts that could not be written-off (those to the IMF and the ECB). That still left the issue of the measures that the Greek authorities were going to undertake in order to close down the existing programme unresolved.
Extend, but not pretend
On the programme, a referendum was held in Greece, which was then interpreted by the government and the parliament as the request for an extension of the bail-out, i.e. as a request for a new loan that will not only enable the existing one to be closed down but will cover the financial needs of Greece in the next three years. So, that was the end of the “no extend” policy (and the Greek minister of finance resigned.) For that, the Greek side was ready to adopt the measures that were already required to end the existing bail-out programme. However, now that there was a request for extension, the “no pretend” was interpreted by the creditors as a need for a new set of financing measures that would ensure that the newly requested loans together with the already accumulated ones would be repaid.
So last Sunday night, no more “extend and pretend” meant that Greece defaulted (“no pretend”) and left the European Monetary Union (“no extend”), perhaps with all sides pretending that it will re-join in few years. Instead, “extend but not pretend” approach has been adopted together with the latest proposal or rather set of demands by the Eurogroup. Those cover in detail primarily the measures that are deemed to be necessary to end the existing programme and start the negotiation on the new credit from the ESM (in excess of 50 billion euro; more than 80 billion if the remaining bail-out money and IMF loans are included).
Extend and reform
Given that there will be an extension, what could the end of pretension mean? On one hand, that debt will be honoured by legislating a fiscal policy and regulatory reform that will ensure that no future extension will be needed. And that state property will be sold to pay back part of the debts, recapitalise the banks, and reinvest in development programmes. The content of these measures would have probably been better had it been put down by the Greek authorities, but that chance was largely missed. The cost will fall on the pensioners and wage earners primarily, because pensions and the public sector wage bill are the largest items in the budget and the ones that are most directly under government’s control (though there may be legal issues when it comes to pensions). Similarly, VAT hike will increase the burden of the poorer households and of small businesses. No more pretence there.
On the other hand, the Eurogroup and the EU will have to accept the fact that in a monetary and banking union once a common bail-out mechanism has been set up, certain mutualisation on public debt has been accepted. So, further indirect write-off of the Greek debts is what the restructuring of the debt will in the end mean. That is what the extension without pretension will mean for the Eurogroup member states (see Note 1 below).
New “extend and pretend” policy
The prior measures will continuously have to be taken by the Greek government and pushed through the Greek parliament, apparently to shore up trust. That will, most probably, be a spectacle of “extend and pretend” because the Government will have to make pretence that the deal to extend debts is favourable to Greece. Initially, a sign of relief by the public is expected, because the ECB will offer support to the banking system and gradually the financial system will be normalised. But it is unrealistic to expect that the Greek public will wholly buy the pretence that it made sense to vote for Syriza and to support it in the referendum in order to extend the ever growing burden of debt that needs to be paid back with even lower wages and pensions.
On the creditor’s side, they will have to pretend that they have actually solved the Greek debt problem and the problem of sustainability of the European Monetary Union. What we have ended up with is another round of “extend and pretend”, which is perhaps the most we can hope for in order to preserve stability of the euro area and the EU (see Note 2 below).
Note 1: Most of the Greek debt after the new bail-out programme is agreed on will be owed to the EFSF (European Financial Stability Fund) and ESM (European Stability Mechanism). Debts to ECB and the IMF will be also implicitly guaranteed by these Funds. These two Funds borrow on behalf of Greece, so Greek public debt is basically guaranteed by the EU member states that own these Funds. The risk they take is measured by the difference in the net present value of Greek debt calculated at Greek sovereign discount rate and that of the Funds. Basically, the Funds borrow at low risk and lend at high risks. The difference, e.g. of 5 percentage points is the expected loss or write-off in the end. That is the extent of the fiscal mutualisation of public debts in the EU or rather within the Eurogroup. More generally, in order for all the members of the monetary union to enjoy the advantage of the same interest rate set by the European Central Bank they need to mutualise fiscal risks to the extent that the interest rates would differ across countries if they were outside of the monetary union. This basically determines the amount of fiscal sharing via the stabilisation funds.
Note 2: The risk of loss is justified by the hope that supply side reforms of all Greek markets and of the regulatory and legal system will speed up Greece’s potential growth rate and bring its economy on the path of convergence. Failing that, ex post losses will be lower than the ex ante ones; i.e. writing off the Greek debt now would be more expensive than writing them off later when it is hoped growth prospects in the euro area will improve and additional instruments to safeguard its stability are developed. So, “extend and pretend” now serves the same purpose as it did in 2010 and 2012. Everything, however, depends on the ability to further strengthen the banking union and increase fiscal interdependence.