Greece won't destroy EMU, Allianz says

The difficult fiscal situation in Greece will not cause lasting damage to the European Monetary Union, according to a new report by Allianz.

Allianz Group is reported to hold €3.6bn in Greek government bonds.

Michael Heise, chief economist and head of corporate development, said: “The problems in these countries are nowhere near as dramatic as in Greece, so a comparison is not justified. There is no danger that European Monetary Union will fall apart.”

In an international comparison, EMU as a whole fares relatively well with a debt ratio of 78.2 percent of gross domestic product (GDP). Japan’s debt ratio of around 190 percent is substantially higher, although that is balanced out by huge sums owed to the country.

The USA, with 83.1 percent of GDP, also fares worse than the euro area.

Greece, along with other euro area countries with financial problems, must now present a convincing fiscal consolidation concept. Empirical studies and various country examples from the past show that a drastic consolidation drive can have a positive impact on growth.

“A plausible consolidation program eliminates false incentives, buoys investment and private consumption and, in the medium term, can trigger a surge in growth,” said Heise.

Should Greece implement an austerity package which lowers the borrowing requirement in 2010 to the planned 8.7 percent of GDP, the Allianz economists expect GDP to fall by around 5%. The economic nosedive will start to slow as early as 2011/2012. The markets will honor the reduction in new borrowing and spreads on Greek government bonds will fall substantially. The level of debt is already likely to fall slightly in 2013. All told, this means that, even with a rigorous austerity drive, the situation of Greek public finances will remain very difficult for a longer spell, but the momentum of the rise in debt can be stopped soon.

The present crisis in the euro area has unleashed a discussion about the management of debt crises. One proposal is the introduction of a European Monetary Fund which could grant conditional loans to a country in financial difficulties. But such a fund does not make sense, necessitating the founding of another EU institution, permanently tying down budgetary funds, and above all reducing the incentive for resolute consolidation.

Heise: “The discussion should not focus on the management of casualties but on crisis prevention. There is no need to re-invent the wheel. The Stability and Growth Pact already has a preventive arm which can be expanded.”

According to the economists, a clearly defined deficit cap should be anchored in the EU treaties, prohibiting a deficit for all EMU countries under normal economic conditions from a certain year. This cap should be embellished with concrete rules on spending, limiting spending growth, say, to at least two percentage points below nominal GDP growth. Countries with high levels of debt should face sanctions if they fail to balance their budget or reduce their outstanding debt sufficiently. The present deficit proceedings should be radically simplified and shortened and the position of the EU strengthened.