Europe

European finance ministers met earlier today and afterwards stated that new proposals from the Greek government were "broadly comprehensive" and "a solid basis" for restarting talks, but made clear that the Greek plan was far from complete and received too late for a deal to be concluded today. Markets had rallied earlier on hopes of a deal. But they fell back on comments from German Finance Minister Wolfgang Schauble and others who saw little new in the Greek proposal, suggesting significant splits among creditors. Leaders meet this evening, but it now appears that critical decisions will wait for the next finance ministers’ gathering, likely Thursday. Separately, the European Central Bank’s (ECB) board again expanded emergency assistance by 2 billion euros to Greek banks after weekend ATM withdrawals and orders for today reportedly exceeded 1.4 billion euros. With today’s modestly constructive statements though, it will be difficult for the ECB to cut off access to Greek banks over the next few days even in the face of broad insolvency in the Greek financial system. The new Greek proposal reportedly includes concessions on the value added tax (VAT) and a small move to limit the early retirement schemes that are a major contributor to the pension deficit. There appears to be broad consensus among creditors—if there is a deal—to provide financing to cover upcoming debt maturities, and they have signaled their willingness to commit to debt restructuring if Greece adheres to the program. But there appear to be many gaps in the Greek proposal, and a lot that can go wrong over the next few days. I would also expect pressure to mount on Prime Minister Alexis Tsipras back home.  Already, minority coalition partner ANEL said cutting the 30 percent VAT discount for the Greek islands, one of the most egregious examples of fiscal excess, would be reason to leave the government. It is also worth commenting on the dynamic between finance ministers and leaders. One recurring feature of the European crisis negotiations of the past several years is the desire of finance ministers to prevent their leaders from giving away too much to get last minute deals.  Consequently, even if the aim is to encourage negotiations, ministers will be wary to suggest a deal is close and will insist that negotiations remain with them. Negative comments from Finance Minister Schauble and others need to be interpreted in that light, and are likely to successfully dampen any hopes for a breakthrough at the leaders’ summit tonight. We will need to wait for more details on the Greek proposal.  If there is to be a deal, we know what it should look like to generate sustained Greek growth within the eurozone. But it is hard to be more optimistic this morning that the parties are closer to concluding such a deal.  The IMF in particular is likely to be quite disappointed with where negotiations seem to be headed. I share that concern, and fear that any deal being discussed is a "bridge to nowhere".  The risks of banking controls and default appear to remain high.

It is time for banking controls in Greece. Delay at this point will only compound the chaos. Consider the following. Thursday’s meeting of Euro-area finance ministers made no progress toward a deal. That was not surprising. What was more noticeable was the discord that followed. IMF Managing Director Christine Lagarde summed it up: for a Greek deal to happen, there will have to be “adults in the room”. There will now be an emergency leader’s summit on Monday, but absent a major U-turn by the Greek government, that meeting is likely to turn to a discussion of “plan b.” Against this backdrop, there has been a rapid acceleration in outflows from the banking system, reportedly in excess of €2bn in the first three days of week. Deposit flight likely will intensify tomorrow and Monday. The ECB will hold an emergency phone call this morning to decide whether to expand emergency assistance (ELA) to the Greek banking system from its current limit of €81 billion. To keep the banks open, the ECB will need to provide a significant injection of liquidity. They should not do it. Greek banks are clearly insolvent. The crisis has caused a spike in non-performing loans, the economy is deteriorating rapidly, and with the Greek government on the verge of default to the IMF, the ECB can no longer pretend that the Greek government bonds that the banks have provided as collateral for past loans are adequate protection against loss. (Arrears to the IMF do not force other creditors’ claims into default, but the political statement of non-cooperation would be powerful unless serious negotiations are underway.) Further, ready access to central bank liquidity has disabled an important source of market discipline on the government, throws good money after bad, and creditor frustration with the continuing demands for financing make the politics of a deal all the more challenging. The Greek government is likely to resist imposing banking controls, but absent an agreement with creditors controls on deposit withdrawals and cross-border transfers look unavoidable once ECB liquidity support has been curtailed. Controls will buy some time for the government, but how much is unclear. The immediate challenge is fiscal and domestic. The government reported a sharp fall in fiscal revenue last month, reflecting a declining economy and substantial tax non-compliance. In response, it has slashed spending and delayed payments to suppliers and contractors. But large-scale arrears are causing significant payments difficulties in the broader economy, and are not sustainable for long when banks can’t lend. For this reason, I am skeptical that the government can sustain deficit spending for long through creation of IOUs, a informal secondary currency within Greece. How the government responds to these fiscal challenges will go a long way to determining whether controls are a way station to Grexit or, as elsewhere (e.g., Cyprus), breathing space to restructure and adjust within the currency union. My colleague Sebastian Mallaby has an excellent discussion of the perils for Greece of heading down this path, and he makes a convincing case that Grexit is not an easy option. The converse is also true. The international community has coalesced around the policies needed to put Greece on a sustainable path within the Eurozone. That includes additional debt relief and perhaps as much as 2 percentage points of GDP in new measures this year alone—including to pensions, wages, and taxes—measures that the Greek government has firmly rejected and that would be a major economic and political challenge to pass and implement. If Greece were to accept the deal, Europe would need to provide additional debt relief to make the numbers add up, a point recently emphasized by the IMF. Tough decisions are called for on both sides, and the prospect for bridging this gap is looking increasingly remote. While the temptation thus exists to buy time by extending the current program, trading cash for partial reforms, and putting off negotiations on a third bailout until the fall, it is a “bridge to nowhere” if it doesn’t put Greece on a credible path back to sustainable growth.            

Negotiations continue today between Greece and its creditors, with reports that the government has presented a revised proposal that offers minor concessions in an effort to break the deadlock. A deal is needed in the next week if a package of assistance is to be put in place before end-month payments of $1.7 billion are due to the IMF. While this is not a hard deadline—a short-term default to the IMF need not sink the Greek economy—the government is out of cash and it is hard to imagine how they make critical domestic payments without an injection of cash from creditors. At times like this, the focus is always on getting a deal done, but this negotiation, even if successful, is likely to defer hard choices for a few months in the hope that Greek domestic politics will change to allow a third bail-out program. The two sides are far apart, both in terms of the policies that need to be taken in the short term and the longer term vision for restoring growth. It is hard not to conclude this is a bridge to nowhere.  A few points. The two sides are farther apart than the headline numbers suggest. The revised Greek proposal offers a primary surplus of 0.75 percent this year, 1.75 percent in 2016 and 2.75 percent in 2017, compared to the creditor proposal of one, two and three percent, respectively. Seemingly small amounts and one could wrongly conclude the sides are close, but these numbers mask major differences in policy. With current policies, Greece will run a primary deficit this year of around 2/3 of a percent of GDP, and if the government moves ahead with proposed changes to labor and pension laws, the deficit could be substantially larger. Partly this deficit reflects the fall in activity, partly it reflects policy measures from the new government. Thus, even to hit the Greek targets require around 1½ percent of GDP in new measures this year, and substantial additional reforms in subsequent years. This is a lot to ask of a government built on a fragile coalition of interests and elected to do the opposite. Elections have consequences. The core policies in any deal are well known. Creditors have outlined a set of proposals that will need to form the basis for any deal. They reportedly include: (i) an increase in the VAT, currently one of the lowest in the EU, to raise collections by 1 percent of GDP; (ii) public sector wage cuts of 1 percent annually starting next year; (iii) pension cuts of around 1 percent of GDP by 2017 to put the pension system on a fully-paid basis; (iv) a redesigned social safety net system saving ½ percent of GDP per year; and (v) a labor consultation process that would put the brakes on the government’s efforts to roll back previous labor market reforms. There are also privatization proposals, but the program shouldn’t hinge on that element given the inherent uncertainty and lags involved. Creditors have signaled a willingness to negotiate the numbers, but it is hard to imagine a deal that doesn’t include these elements. The pension issue appears the most divisive, though creditors should be willing to accept a continuing pension deficit if the amounts are made up elsewhere. While pro-growth in the longer-term, these policies are a near-term drag on activity at a difficult time. To the frustration of Greece’s creditors, the government has failed on multiple occasions to come up with a coherent or well-developed set of proposals to achieve these savings. The revised Greek proposal reportedly focuses on the headline numbers and comprehensive debt relief, instead of the policies. I have long been supportive of substantial debt relief for Greece (and other overly indebted periphery countries), but I also believe that the creditor’s proposals are a reasonable price to ask in return. That is the grand bargain that should be the goal. But while both sides can be criticized, it is hard not to conclude that the government knows what policies are needed to clinch a deal, but that they are simply unwilling or unable at this point to agree to such policies. Perhaps there is a “Hastert rule” in play in Greece, and the government cannot politically go ahead with a program that does not command a majority of Syriza parliamentarians (opposition parties have signaled their willingness to support a deal). The bottom line here is that while the headline differences are small, the policy and political gulf is vast. The G7 closes ranks. At this weekend’s G7 meeting, there was a strong consensus that Greece needed to make tough and significant decisions to get a deal done.  The United States had in recent weeks been seen to be pressing European leaders to compromise, but President Obama’s statement showed little space between him and the other members of the G7:  "What it’s going to require is Greece being serious about making some important reforms not only to satisfy creditors, but, more importantly, to create a platform whereby the Greek economy can start growing again and prosper.  And so the Greeks are going to have to follow through and make some tough political choices that will be good for the long term." Domestic payments are still the trip wire. Even if most or all external debt payments were deferred or forgiven, Greece would still need additional resources in the near term while negotiations on a longer term program proceed. A bank run adds to the needs. The government proposes to meet the need through additional treasury bill issuance, which in the end would be financed by the ECB’s Emergency Liquidity Assistance (ELA). ELA exposure to Greece now stands at around €80 billion, and it is understandable that the ECB is wary of being the lender of first resort for an open-ended transitional period. But without this support, growing domestic arrears and missed payments will have a damaging effect on an already slowing economy and put further political pressure on the government. Banking controls inevitably would follow. In the end, non-payment to the IMF need not cause huge dislocations for the Greek economy. Not paying pensions or government wages in full would. The inflation tax is becoming more attractive. One often-cited advantage from leaving the eurozone is the growth boost that could come from the resultant depreciation, but that presumes that Greece could develop a vibrant non-tourist export sector with a more competitive exchange rate. That is hard to imagine being done easily given current policies. Perhaps a more powerful near-term argument for exit is simply that it relieves fiscal pressure by allowing the government to print money. The inflation tax that results is hugely distortive, but not necessarily more so than the current situation of widespread and growing domestic arrears. In the end, whether there is a deal or not is a political decision with substantial consequence for Greece and also for Europe. But beyond handicapping the deal, it is important to have a path for Greece that restores growth, and it’s hard to see how we are closer to that outcome now than before the most recent crisis.

This is a guest post by Amanda Roth, a former intern for the Council on Foreign Relations Africa Program. She is a graduate student at the Columbia School of International and Public Affairs, where she studies international security policy.  Last week, a ship carrying hundreds of migrants trying to reach Europe capsized in the Mediterranean, killing nearly 900. The tragic incident and unprecedented death toll has reignited a discussion of the growing migration crisis in the Mediterranean and Europe’s obligation to assist. Last year, Italy terminated Operation Mare Nostrum, an extensive and relatively successful search and rescue operation. The operation began in response to the 2013 Lampedusa crash, in which more than 300 migrants died. Under Mare Nostrum, Italy rescued thousands of migrants, housed and clothed them, and attempted to adjudicate asylum claims. However, with challenges of its own, Italy struggled to fund the program and to provide services for all migrants within its own borders. The Dublin Regulation, an EU law, dictates that the European country that is the first point of entry must handle the asylum application, leaving countries bordering the Mediterranean, such as Italy and Malta, overwhelmed by applications. Approximately 90 percent of refugees end up in only a few EU member states. European leaders refused to help fund Operation Mare Nostrum and to accommodate migrants. Some argued that rescue missions served as a “pull factor” and encouraged migrants to make the dangerous journey, knowing that they would be rescued. Unable to foot the costs itself, Italy ended the program. It’s difficult to know if Operation Mare Nostrum could have prevented this week’s tragedy. However, two things are clear. The first is the glaring fault in the logic that ended Operation Mare Nostrum—search and rescue operations in the Mediterranean aren’t a significant “pull factor” attracting migrants. Political violence in Mali, terrorism in West Africa, the Syrian civil war, and continued poverty and oppression mean that just as many people continue to make the journey. The second obvious conclusion is that search and rescue operations are a short-term fix, not a long-term solution. Operation Mare Nostrum helped save thousands of lives, but it could not address the root causes of migration from Africa and the Middle East to Europe. European leaders are gathering in Luxemburg this week to discuss possible solutions—including increased funding for operations such as Mare Nostrum, and targeted missions to arrest smugglers and dismantle their networks. Leaders gathered in Luxemburg this week should look at solutions that may help stem the flow of migrants in more incremental yet sustainable ways. While it is beyond Europe’s capacity to fix violence in Mali or stop the repressive regime in Eritrea, improving its own immigration system may help mitigate the flow and reduce deaths. Providing more funding for search and rescue is one critical step, but like that of the United States, Europe’s immigration system is deeply flawed. There are more creative solutions being discussed. Setting up processing centers in Africa and the Middle East, so individuals can apply for asylum before crossing the Mediterranean, may help. Family reunification processes can be simplified. The EU could revisit the Dublin Convention, which disproportionately burdens poorer Southern European nations with the responsibility of responding to waves of undocumented migrants. Immediately allowing for larger number of asylum claims is critical. These measures won’t stop the flow of migrants to Europe. But, they could keep the crisis from escalating. It is clear that leaders must look beyond short-term fixes, and address this issue in a more sustainable and comprehensive way.

Greece is running out of money. Greek Prime Minister Alexis Tsipras’s meeting this week with German Chancellor Angela Merkel has taken some of the toxicity out of the conversation for now, but cannot mask Greece’s current collision course with its creditors. Committed to a platform on which it was elected but that it cannot pay for, and with additional EU/ECB financing conditioned on reform, the Greek government is likely to run out of money in April (if not before). If past emerging market crises are any guide, the decisions that it will then confront about who to pay and who not to—the politics of arrears—will present a critical challenge to the government and likely define the future path of the crisis. Most analysts continue to argue that a deal that allows Greece to muddle through and avoid an exit from the eurozone (“Grexit”) is the most likely outcome. This argument is usually based on the assessment that there is a deal to be had, that Prime Minister Tsipras is a realistic leader that can over time navigate his coalition to a course that balances democratic accountability and a return to growth with the reforms needed to continue to receive assistance, and that both sides have too much to lose from a messy exit. All this may be true, but the political timeline over which this scenario plays out is measured in months, while the economic timeline is measured in days. The Greek government is now moving to prepare a more detailed set of reforms (including fiscal reform, privatization, social security and labor measures), based on the February 20 Eurogroup agreement, in hope of securing the approval in coming days from eurozone finance ministers. Any agreement reached will require approval by the Greek and foreign parliaments. Interim meetings can at best provide momentum to negotiations that justify short-term financing—most likely in small amounts and conditional on progress—while these negotiations proceed. That means that Greece will soon, perhaps as early as next week, begin to run arrears. How did we get here? Tax revenue collapsed in the run up to the election, and has contracted further in the uncertainty that has followed. Further, in recent weeks, the parliament has approved a number of anti-poverty measures and a payment plan for tax debtors, generating domestic support but taking policy further away from the previously approved program. It is unclear whether more controversial, but necessary reforms could win approval. As a result, even the reduced government primary surplus of 1.5 percent of GDP looks out of reach on current policies. This is not to criticize the government for seeking to keep its election promises, but rather to stress the large and growing gulf between its plans and what European creditors are willing to support. Unsurprisingly, bank deposits have begun to flow out of the system in the past week (reportedly as much as 350–400 million euros on some days), exacerbating liquidity problems. By some reports, Greece needs about 2 billion euros to meet its remaining obligations for March and more for April when it faces material debt payments, including to the IMF. Reports are that it will be able to cover the March pension and wage payments from its deposits and it can tap the reserves of pension funds, state bodies and utilities, but the outlook from then onward is unclear. Greek officials are reportedly considering the use of IOUs for the payment of salaries and pensions, and less politically sensitive payments to suppliers are also likely to lag. In his letter to Chancellor Merkel last week, Prime Minister Tsipras signaled that the government might not have sufficient resources for April and would not make debt payments at the expense of social stability. What comes next? The Greek government would like to tap EU bailout funds, but acknowledges that will take time. In the interim, they are looking for the ECB to provide financing—primarily though the Bank of Greece’s emergency liquidity assistance (ELA) mechanism which now stands around 70 billion—to illiquid Greek banks, which in turn can buy government paper. There should be no mistake that to do so would be pure fiscal financing. Consequently, it is not surprising that the ECB has opposed lifting the 3.5 billion euro cap on the amount of T-bills it will accept as collateral in exchange for central bank loans. What we have seen in emerging market crises in the past is that the running of arrears puts extraordinary pressure on a government, and this new Greek government is unlikely to be an exception. The decision to pay some and not others involves allocative choices that will be new terrain for the government. Suppliers and other providers of government services are likely to see arrears, differing across different sectors depending on the power of the relevant ministries and the revealed priorities of the government. IOUs might circulate but likely would trade at a deep discount given poor liquidity conditions.  Capital controls may be needed to stem flight, putting further strain on the economy. Fissures within the governing coalition could open up. This process is unlikely to be structured and orderly. In the end, should Greece survive the politics of arrears, they will still need a competitive economy and sustainable fiscal finances, and it is hard to see how the government’s current program gets them there. Sustainability can be achieved through Grexit (and the subsequent devaluation and debt restructuring), or it can be done though a rewriting of contracts to get relative prices right and reduce liabilities (“internal devaluation”) followed by an easing of controls. Either is possible, though the experience of Iceland and Cyprus remind us of the difficulty of getting rid of capital controls once they are in place. Either can produce a sustainable post-crisis Greece. That will be a big decision down the road, but for now Greece’s future is likely to be decided by the decisions made in coming weeks on who gets paid.  

The eurozone, once seen as a crowning achievement in the decades-long path toward European integration, continues to struggle with the effects of its sovereign debt crises and their implications for the future of the common currency.

This is a guest post by Amanda Roth, a former intern for the Council on Foreign Relations Africa Program. She is a graduate student at the Columbia School of International and Public Affairs, where she studies international security policy.  Last year, the horrific shipwreck off the Italian island of Lampedusa brought international attention to the dangers faced by the thousands of migrants who cross the Mediterranean Sea to find safety in Europe. The wreck, which occurred less than a quarter-mile from Italy’s shores, killed 366 migrants from Eritrea and Somalia. The Mediterranean is the world’s deadliest migrant crossing, according to the International Organization for Migration, with more than three thousand reported deaths so far this year. That number is up from approximately seven hundred the year before, and accounts for 75 percent of all documented migrant deaths worldwide. More people are making the journey from Africa and more people are dying. In response, the Italian government launched Operation Mare Nostrum. Run by the Italian Coast Guard, the operation has saved the lives of more than 150,000 people. Yet, as of November 1, 2014, Operation Mare Nostrum came to an end, leaving the fate of the thousands of migrants expected to attempt future journeys uncertain. There is no adequate replacement for the now-expired Operation Mare Nostrum. Despite the program’s success, it ended due to “unsustainable” costs. Instead, Mare Nostrum will be replaced by Operation Triton, which is run by the EU and is significantly smaller in scope and has one-third the budget of Mare Nostrum. It will not have an explicit search and rescue function. Instead, the operation will only patrol within thirty miles of Italy’s borders. There is little political support among EU governments for larger search and rescue missions. Last week, the United Kingdom announced that it would not contribute to future rescue missions. Although the country has received harsh criticism for the decision, James Brokenshire, UK immigration minister, defended the choice, arguing that “since Italy launched its Mare Nostrum operation in October 2013, there has been an unprecedented increase in illegal immigration across the Mediterranean and a four-fold increase in the deaths of those making that perilous journey.” Networks of smugglers charge migrants large sums of money in exchange for passage. These human traffickers have been accused of grave human rights abuses, including the rape and torture of migrants. The UK and others accuse the smugglers of abusing existing search and rescue missions by knowingly using unsafe boats and hoping their human cargo is rescued and brought to European shores. Does Operation Mare Nostrum encourage migrants to make the dangerous journey? Although it may contribute, it isn’t the entire reason. Ongoing conflicts and brutal repression in Somalia, Eritrea, and elsewhere have caused tens of thousands of refugees to flee. Turmoil in northern Africa following the Arab Spring means that fewer refugees are settling in Egypt and Libya, preferring to risk the crossing to the EU. While Italy’s Mare Nostrum has saved tens of thousands of lives, it still hasn’t been able to respond to the full scope of the crisis. A few days after the UK’s announcement in October, for example, a boat sank off the coast of Libya. Although the Italian Coast Guard rescued ninety-three people, another twenty African migrants died. Tightened border security, stricter scrutiny of asylum claims, and the close patrol of traditional land routes have driven many migrants to try and reach Europe by sea. Now that Mare Nostrum has ended, many more are likely to die. Despite the United Kingdom’s claims, it’s far from clear that the decision not to support rescue missions will reduce the numbers of people making the journey. Will the European Union really turn its back on the thousands of refugees trying to reach safe shores?