The gravity of the Greek debt situation is underlined by the growing acceptance among policymakers in Europe that default is possible — or in the view of some, inevitable — for Greece, writes Oxford Analytica. Attempts to ring-fence the default option while excluding Greece’s simultaneous exit from the euro-area are becoming ever more difficult.
The more the argument is reduced to just two scenarios, whereby Greece defaults and either remains in the euro or leaves, the harder it will be to avoid a self-fulfilling prophecy.
One key indicator in the coming months is the dynamics of Greece’s primary budget balance — that is, the fiscal balance not counting interest payments. As long as Greece has a primary deficit (as has been the case for a decade), the incentive to default is very limited. At present, the primary deficit is higher than Greece’s debt service obligations. Thus, even in the event of a default in the coming months, Greece’s budget shortfall would still be daunting.
The moment this dynamic changes and Greece achieves a primary surplus, the rationale for a default may be subject to re-evaluation. At this tipping point, it could be in the self-interest of the Greek authorities to trigger a default mechanism. Finance Minister Evangelos Venizelos recently made the optimistic forecast that Greece would register a surplus before interest payments on its sovereign debt obligations of 3 billion euros during 2012.
If the recovery potential of the real economy is pushed back beyond 2012 and its finances continue to underperform for the rest of the year, it is merely a matter of time before Greece’s lethal interplay becomes unsustainable. The IMF has already threatened to withhold its share of the sixth tranche to be paid in early October. If not this time, a future quarterly evaluation by the troika might arrive at the assessment that non-compliance with agreed targets can no longer be tolerated or sanctioned through the provision of further instalments of bailout funds.