Greece requires the largest rescue ever

Greece’s potential bankruptcy has resulted in by far the largest cash bailout of any single country in history – €110 billion.

The deal struck on Sunday has angered EU taxpayers, especially Germans who will contribute the largest loan payment.

But Greek citizens are even angrier as they now enter a gloomy period of stinginess and government spending cuts worth €24 billion over the next four years as part of the loan’s conditions.

So why bother saving Greece when it only seems to upset them?

The Crisis

Over the past decade the Greek government has borrowed billions of euros from European banks to fund its excessive spending spree.

Now those loans are coming up for repayment but the government simply doesn’t have the cash available.

It has tried borrowing more from the banks but they are only prepared to lend at expensive interest rates of 7-8% – twice what the German government borrows at.

Such high interest rates would only cripple the debt-laden Greek government even further. Bankruptcy (the inability to pay one’s debts) would certainly follow.

The reality of a Greek bankruptcy would scare banks into demanding higher interest rates when lending to Portugal, Ireland, Italy and Spain – the other debt-heavy ‘PIIGS’ countries (Portugal was last week given a riskier credit rating).

These governments currently need bank money at a reasonable interest rate (under 5%) so they can pay off their existing debts and spend their way out of recession.

Without it, they too would face bankruptcy.

However, the other EU countries simply don’t have the trillions to rescue them all, so the strong European economy and currency would consequently collapse.

This is why Europe has been forced to act.

The Deal

EU taxpayers who use the euro currency (Germany, France, Italy, Netherlands etc) will lend Greece €80 billion over three years, starting May 19.

Another €30 billion is coming from the IMF (International Monetary Fund – the bank for seriously troubled countries). Both loans will be at 5% interest.

This will be used to pay off the Greek government’s bank debt – a lot of which belongs to German and French banks – and replace it with EU and IMF debt.

At the same time (so all debt can eventually be repaid), the government is required to do three things.

The first is to cut government jobs as well as spending on pensions and public sector pay packets.

The second is to increase taxes on fuel, cigarettes, alcohol, gambling and property, and an increase in VAT (goods and services tax).

The third is to actually do a proper job of collecting taxes. A corrupt culture of cash payments and tax evasion has severely minimised the country’s tax revenue.

With these measures, the hope is that by 2014 the Greek government will be almost profitable, and able to start reducing its debt (which will peak in 2013 at 149% of the country’s entire economy).

The Consequences

Despite the deal’s hopes, it’s still an enormous risk for the EU.

As Greeks have shown (and are scheduled to do again tomorrow), they are not taking their pay and pension cuts lying down.

Protests and riots have rocked the country. Behind closed doors, worker unions are fighting equally vicious legal battles. This indicates some of the promised spending cuts might not eventuate.

And already a few of the country’s wealthy (whose tax dodging ordinary Greeks blame for creating the problem) are reportedly moving to other countries to avoid the new taxes at home.

In the middle of a serious recession (their economy will shrink by a further 4% next year), this leaves the Greek government’s future economic health and repayment abilities in serious doubt.

The German Chancellor (president) Angela Merkel has been forced to rescue Greece with German money and now risks an election backlash in her own country.

Greek Prime Minister George Papandreou is running the same election risk as his spending cuts and tax increases take hold.

Indeed, everything seems to be resting on one key element – the IMF’s promise and ability to make sure Greece implements its loan conditions to the letter.

If so, Greece will benefit in the long run. Germany and other EU lenders will actually make a profit (rather than a loss) on the transaction. And other PIIGS countries will see the harsh treatment the IMF gives and take whatever steps they can to avoid such a bailout.

Financial markets (banks and companies) will also see real progress and therefore be more at ease about lending at lower interest rates.

However, a lot of things still have to go right if Europe is to get out of this mess. It seems economic pain in the short term is the only certainty.

By The Casual Truth