Former Greek PM Papademos on WSJ: “No Choice But Austerity”

Greece΄s former Prime Minister Lucas Papademos warned that Greek people have no choice but to stick with a harsh austerity program imposed by their lenders or face an exit from the Eurozone which could result in the financial collapse of the country by boosting inflation and cause social strains.

In his first long-expected interview after having delivered his office last week, Papademos told The Wall Street Journal that dropping the common currency would have “catastrophic” economic consequences for Greece and profound and far-reaching implications for the rest of the Eurozone. This is why some European states and institutions are considering contingency plans for any eventuality, he added.

“Although such a scenario is unlikely to materialize and it is not desirable either for Greece or for other countries, it cannot be excluded that preparations are being made to contain the potential consequences of a Greek euro exit,” Papademos said.

Papademos, who has served as European Central Bank vice president, continues to offer his advice to the new caretaker government that was appointed last week following inconclusive May 6 national elections that led to a parliament fragmented by a strong anti-austerity protest vote.

The new polls set for June 17, which, as widely believed, amount to a Greek referendum on remaining in the Eurozone, will be quickly followed by tight deadlines for a new government to deliver more spending cuts to keep qualifying for aid under the country΄s second financial bailout by international lenders.

Papademos said he worries that many Greeks don΄t fully appreciate the gravity of the situation. “European political leaders have sent a clear message comprising two parts: Greece should remain in the Eurozone and the country should respect its commitments. Hence, the risk of Greece leaving the euro is real and it depends effectively on whether the Greek people will support the continued implementation of the economic program,” Papademos said. “I share the view that if Greece defaults and exits the euro, the consequences for the Eurozone – its financial system and real economy – will be profound and the associated cost will be significant and far-reaching. It will also affect the economies of other countries outside the Eurozone.”

He quoted estimates that the overall cost of a Greek exit could range from €500 billion to €1 trillion ($639 billion to $1.28 trillion), which reflect assumptions on the impact on market valuations, cross-border contagion effects and damage to the real economy.

Time is running short, he said. Without further aid, Greece would soon be unable to pay pensions and public-sector wages.

According to recent finance ministry calculations, the country will have sufficient resources to cover its expenditures until June 20, given the circumstances. But tax collection has slackened and revenue has fallen behind targets, meaning funding strains may appear in the first two weeks of June. If necessary, the government could tap funds held by the Hellenic Financial Stability Fund that are supposed to be used for bank recapitalizations.

By the end of this week, the HFSF is expected to distribute €18 billion in fresh bailout funds to Greek banks to boost their liquidity, after which it will be left with a cushion of €3 billion.

There is no upside to a Greek departure from the euro, Papademos said. The impact of a sharp devaluation in a new national currency would erase any competitive gains in foreign trade.

According to Papademos΄s exit scenario, Greek inflation will accelerate, real incomes will shrink, the banking system will experience extreme stress and Greece΄s access to the capital markets will become more remote. Greece΄s public debt will increase because it will be denominated in the new currency, and then higher real interest rates would be required to stabilize the exchange rate and bring inflation under control.

“Some calculations I have seen suggest that inflation could accelerate to 30% or even to 50%, depending on the impact of such developments on inflation expectations and on the strength of the second-round effects of price increases on wages,” he explained.

Such an inflationary spiral would effectively offset the short-term beneficial impact of the devalued new national currency on price competitiveness, he added.

“Overall, the economic consequences…would be catastrophic. Moreover, the adverse political and social implications of an exit from the euro would also be profound and long-lasting,” he said, pointing to a recent spurt in discontent as the youth employment topped 50% of the workforce in that segment.

Papademos stressed that “for the second program to be successful it is essential that the fiscal-consolidation measures and structural reforms should be supplemented by additional policies that would have an immediate and significant positive impact on economic activity and employment.”

But he said promises by party leaders that Greece could back off or renegotiate these bailout terms were a mistake.

Equally misguided, he said, are expectations by the far-left Syriza political group, which surged in the last election and is now neck-and-neck with the largest mainstream conservative New Democracy party, that Greece΄s Eurozone partners will blink and won΄t force it out of the euro, even if it suspends austerity measures and defaults on its loans.

“Those countries already faced great difficulties in persuading their parliaments to approve the second bailout program, while other member states like Spain and Italy, with serious fiscal challenges, would be asked to contribute further to the financing of Greece,” he said.

“Adjustment fatigue in countries under programs has been accompanied by bailout fatigue in creditor countries. We should not forget this.”