With the German government’s austerity mania losing them friends, it’s looking increasingly likely that the new Syriza government will get a deal on Greece’s debt

It’s now clear that the Syriza government, just as uber-confident finance minister Yanis Varoufakis predicted, will most likely get a deal on Greece’s debt. The turning point happened over the last few days; following reports in the Greek media that Barack Obama had telephoned through his support to Alexis Tsipras, the US President’s public statements have made it very clear to Germany’s leadership that their austerity mania is losing them friends.

Meanwhile, the case for Greek debt write-off is overwhelming, and gaining ground. Greece’s debt is totally unpayable in any plausible scenario and, if the country is to have even a hope of recovery, must be reduced. The critical issue here is, as James Galbraith points out, not so much the total stock of debt. This is now held by official institutions, such as the European Central Bank (ECB), who between them account for 85% of Greece’s outstanding 317bn euro debt. That means in practice the strictly economic consequences of this stock of debt can be parked: the decision to write off, or not write off, the debt is now largely political. (Syriza have always, even before the election, ruled out forcing through more write-downs on private sector creditors.)

But it also means that the size of the outstanding stock of debt isn’t the main issue here. What’s absolutely critical is the extent of the payments needed to service the debt. How much must the Greek government (and that means the Greek people) stump up to meet repayments – and for how long?

The problem is simple: if they’re paying a debt, they’re not paying for schools and hospitals, or anything else. And, more generally, by shovelling cash towards creditors, they’re not spending money in the Greek economy. That hits demand, and that, in turn, helps explain why the Greek economy has shrunk so much since 2009.

A large debt implies many heavy repayments, potentially over a long period of time. A small debt does not. So reducing the absolute size of the debt can immediately help. A simple write-off of the debt would very quickly reduce Greece’s debt burden. But a reduction in the repayments would reduce the effective debt burden.

Debt restructuring

Varoufakis has proposed, as of Monday evening, a deal with Greece’s creditors – remember, mainly by now other eurozone members – that does not write off the debt as such, but would reduce the burden of payments. The existing debt would be converted into two types of new loans. The first would be “index-linked” meaning, in this case, that Greece would only start repaying once GDP growth had hit a certain point. (If you think this sounds like a British student loan, you’d be right: the principle of income-contingent payments is exactly the same.) The second type the Greek finance minister has called “perpetual bonds”, which would replace money owed directly to the ECB. Essentially, these would be loans with no fixed repayment schedule, to be paid as and when (in practice) the debtor felt the urge to.

It’s not a debt write-off. It doesn’t cancel Greece’s debt outright. It should reduce the immediate burden on the Greek state, potentially (when and if the deal is agreed) by a substantial amount. If agreed to, this would a major climbdown by the ECB and the German government in particular, the latter of whom have, until now, steadfastly refused any alteration in the terms of the debt. But it’s still a compromise on the original aim, and it contains the possibility of future problems. Complex debt deals invariably do; the entire 2007-8 crisis was kicked off by the failure of complex deals in the repayment of debts, the infamous Collateralized Debt Obligations (CDOs). Whatever deal is signed to benefit Greece, there will be devious minds sitting in hedge funds across the world, thinking how to make the deal work for them. This is the merit of simplicity in a financialised world: it kills off opportunities for rent-seeking. Moreover, the debt will still exist: Greece will still, at least in theory, remain at the beck and call of a creditor.

Primary surplus

The second part of Varoufakis’ plan is more concerning. He has also offered that the Greek government will generate a primary surplus of 1.5% of GDP. The “primary surplus” is the gap between what a government gets in taxes, and what it spends – excluding, critically, interest payments on its debt. It’s the opposite of a government deficit, in other words. It means the government is earning more than it is spending – and spending the spare cash on debt payments.

This is an improvement on the current Troika demands, which call for a primary surplus of 4.5%. This is, for an economy in the state Greece is in, criminally tight. It implies making massive cuts to public spending, which of course cripple wider economic activity, and doing so (in effect) to meet interest payments demanded from creditors. A 1.5% primary surplus would be an improvement on what is increasingly recognised as a ludicrously tight figure. It would mean easing the pressure on public spending very substantially. But it is still some distance from Varoufakis’ and original claim to be looking for merely a balanced budget (that is, the government would simply spend what it got).

In theory, a primary surplus doesn’t have to mean cuts. In theory, it is possible for Syriza to clamp down on Greece’s tax-dodging wealthy, make them pay their dues, and avoid cuts to meet the target. That is what Syriza has always said it would do. In theory, this makes sense.

In theory. In practice, what aiming for a primary surplus does is shifts the entire burden of meeting the target onto the Greek government’s shoulders. If it was intending, Keynes-style, to run a deficit, that burden would be hugely lessened: a little political breathing space, at least, would be provided.

As it is, Syriza will (if it aims for this target) have to rapidly and efficiently reform Greece’s tax system, with a state battered by five years of austerity and in the midst of an ongoing economic crisis. Reforming the Greek tax system is something that no other party has managed in the forty years since the dictatorship fell, come rain or shine. It’s certainly possible Syriza’s new kid on the block status helps here: it’s just not connected to the old networks of cronyism and patronage in the way New Democracy and Pasok are. Lacking these ties, it should find taking on powerful vested interests rather easier. But it’s a tough call.

ECB applying pressure, Germany playing a waiting game

They are in a tight place. Greek banks are, to all intents and purposes, insolvent. Forty percent of Greek bank loans are nonperforming, according to the IMF. In other words, these debts are just not being paid, leaving the banks without sufficient earnings to meet their liabilities. Large sums are now leaving the country, as wealthy Greeks and other investors remove their cash to perceived safer locations. Money in the system (liquidity) has tightened over the last month or so, as many Greeks look to remove their cash from their bank accounts, fearing a banking collapse. It has been revealed that three out of four large Greek banks have applied Emergency Liquidity Assistance (ELA) funding, with 2bn euros disbursed since 21 January. ELA funding is provided by the Bank of Greece (Greece’s national central bank) but only with ECB approval. This credit lifeline is currently keeping Greek banks alive.

If there is a full-blown run on Greek banks, leading to their collapse, it’s game over for the Greek economy – at least as a euro member. Banks would need recapitalising, but an insolvent or near-insolvent government can’t do that itself. Short of finding some other wealthy international backer, the government would likely have to exit the euro and attempt to recapitalise the banks with the new currency.

The ECB knows all this. They have been putting the squeeze on the Syriza-led government at its weakest point – the Greek banking system. Knowing the leadership doesn’t want to risk “Grexit”, they have leaned hard on them.

For its part, Germany, the obviously dominant government inside the eurozone, is reported to be playing a waiting game. Letting Greece twist in the wind now means its government could, within a few months – and perhaps as early as March – run entirely out of cash and be forced to beg for assistance on almost any available terms. They therefore may be in no hurry to conclude a full deal, but will probably allow some emergency assistance over the next few months. Merkel may then be able to regain the initiative from Syriza.

This all leaves Varoufakis and company in an unenviable position. It remains likely a deal will be struck, at some point, given the international pressure now being brought to bear on Germany and other eurozone creditors, and the comparative security of the Syriza leadership. But it looks like one in which Greece, by closing off the option of leaving the euro, have left themselves in a weaker position. There is a solid anti-euro left bloc inside Syriza that may well now start to make its presence felt. And of course, should Syriza hold on, there are the prospects of further political eruptions across the European south. Elections in Spain could see the return of an anti-austerity Podemos-led government by the end of the year. This would, in theory, ease the pressure on Syriza dramatically. The situation remains tense, but open.