The Final Proposal

The Greek government finally surrendered to demands of its creditors for severe austerity measures and comprehensive economic reforms that are largely in line with creditors’ long demands, thus raising questions as to what did prime minister Tsipras achieve in five months of deadlock, angst and the lock-down of his banking sector? 

This was well explained by Greece’s former finance minister Yanis Varoufakis who argued that while previous negotiations were being conducted to unlock the final tranche (equivalent to €7bn) of Greece's second bailout programme, the current dialogue is being undertaken to finalize a third bailout package worth €53.5bn that is expected to run for three years. In addition, Greece has managed to get the International Monetary Fund  

(IMF), European Union (EU) and United States (US) to take a hard look at its debt burden and consider measures to make them sustainable, which was previously not the case. 

Although the final proposal does not explicitly cover debt relief, Athens has sent a release to the media stating that they are in fact seeking regulation of their debt (i.e. haircut and restructuring) and the €35bn investment package earlier promised by the president of the European Commission, Jean-Claude Juncker. Given the punitiveness of the proposal, international observers have argued that some form of humanitarian aid to Greece cannot be ruled out too. President Juncker had mentioned aid as part of the Grexit plan, but diplomats in Brussels have hinted at some form of assistance even if an agreement is reached in order to tone down the social strife in Greece that may arise in reaction to the harsh austerity measures that are on cards. The detailed Greek proposal that entails public spending cuts worth €13bn subsumes among other things, 

• Fiscal measures to achieve a primary surplus (i.e. government income minus expenditure, excluding interest paid on government debt) target of 1%, 2%, 3%, and 3.5% of GDP in FY15 and beyond,
• VAT reforms and tax policy measures to address shortfall in tax collection,
• Pension and public administration reforms, and 
• Privatization

A last minute compromise?

The detailed reform proposal forwarded by Greece on Thursday has raised hopes of a compromise deal being signed at the emergency meeting of EU leaders on Sunday, with Irish finance minister Michael Noonan stating that Greece can strike a third bailout deal this weekend as mood at the negotiating table has improved drastically since the arrival of its Greece’s new finance minister Euclid Tsakalotos.

But equally important is the position of creditors on the issue of debt haircut in return for the bitter austerity bullet that Greece has accepted to bite. The president of the European Council Donald Tusk has already argued that it is imperative that a convincing proposal from Greece is matched by an equally realistic proposal on debt sustainability from the creditors. And this sums up the basis for a compromise to keep Greece in the Euro Area. Though France, Italy and Spain had no objection with debt relief being granted to Greece, the largest economy in the Eurozone (i.e. Germany) had flatly refused any concessions on the same. However, there seems to be some positive movement from all quarters as we head to the fateful EU Summit on Sunday. Germany seems to have softened its opposition to debt relief in last 24 hours following strong pressure from many quarters including the IMF, US and France. Thus a commitment to extend maturities and reduction in interest rates looks likely, if not nominal debt haircut.

The Greek proposal has been sent to the Eurogroup finance ministers and has been voted by majority in Greek Parliament today as a prior action and mandate for Sunday’s negotiation. Although Greek prime minster Alexis Tsipras has urged his countrymen to rally behind him and back the austerity proposal, but only time will tell whether creditors consider these measures as sufficient in light of the sharp deterioration of the Greek economy in recent weeks. The Eurogroup finance ministers are scheduled to meet on Saturday, ahead of the EU Summit on Sunday, to decide on Greece's third bailout request and temporary financing arrangements from the European Central Bank (ECB) to keep Greek banks afloat. And in a major boost to Greece before the aforesaid meeting, France has already deemed the proposal as being credible and comprehensive. 

A deal may bring to an end five months of agony for the Greek citizens but a negative outcome would launch a long and messy process of Grexit. Nevertheless, with a compromise deal looking to be in sight, markets in Europe and US surged as investors sensed a glimmer of hope. Bond yields for indebted European nations declined too with Italian 10-year bond yield falling by 0.05% to 2.17%, while the Spanish 10-year yield declined 0.06% to 2.16%. Signs of Greek progress also had a positive impact on the EUR/USD pair which witnessed a minor spike to 1.12 in the early European session.

The Greek reform proposal in detail

Fiscal Structure measures:

The proposal seeks to increase corporate tax rate from 26% to 28%, phase out the preferential tax treatment for agriculture income, abolish subsidies on diesel oil for farmers, eliminate cross-border withholding tax, reduce prices of off-patent and generic drugs, limit the prices of diagnostic tests, strengthen framework for independent agencies to strengthen tax collection and oversee government finances, introduce tax on television advertisement, increase the rate of tonnage tax, and phase out special treatment of shipping industry. The reform list also includes reduction in military spending to the tune of €300mn over next two years, increase in luxury tax on recreational vessels from 10% to 13%, taxation on video lottery terminal (VLT) gaming, and auction of 4G and 5G licenses to generate revenues.

While many of the aforesaid steps are positive, others may result in squeezing the economy even more, particularly additional taxes on corporate sector and shipping industry. For an economy whose nominal GDP has shrunk by almost 25% in last eight years, increased taxation on the corporate sector might end up making the economy further uncompetitive. Similarly, Greece has long maintained the leadership in the international shipping industry and levying further taxes on a highly cyclical industry that is marred by a slowdown in global economy could put it under further strains. Equally punitive is the withdrawal of subsidies to farmers who are generally the poorest lot. Abolition of withholding tax could be beneficial though, as it will incentivize the flow of private capital in a highly strained economy.

Tax reforms:

On the taxation font, the VAT reform will target a net revenue gain of 1% of GDP on an annual basis by levying a unified rate of 23% on all good and services including restaurants – a key battleground before. A reduced rate of 13% will be applicable on basic food, energy, hotels and water, and a super-reduced rate of 6% on pharmaceuticals, books and theater. Corporation tax will be levied at 28% and measures will be introduced to broaden the tax base and crack down on tax evasion to improve collections. Various tax exemptions will also be eliminated, particularly on islands with high incomes which are popular tourist destinations.  

The VAT reforms are amongst the most desirable which were long overdue. Greece has one of the largest gaps in the EU on VAT revenues because of a highly complex structure with myriad preferential tax treatment and exemptions, thus leading to significant leakage in the system. On the other hand, additional taxation on restaurants, tourist islands and other tourism related amenities will only harm an economy that is heavily dependent on tourists for revenues.

Pension and public administration reforms:

The proposal recognizes that the pension system in Greece is unsustainable and needs fundamental reforms and proposes to undertake steps that will deliver savings upto 0.5% of GDP in FY15 and 1% in years thereafter. The proposal also seeks to extend the retirement age to 67 years by 2022, create strong disincentive to early retirement, better target social pensions, gradually phase-out solidarity grant by 2019, and post June 2015 provide to people, first contributory pension only at the attainment of statutory retirement age, and second link retirement benefits with the contributions. Also subsumed is rationalization of public sector wages and benefits in line with skill, performance and responsibility of the staff. 

Greece’s overburdened pension system, endemic tax fraud, widespread corruption and the frequent complicity of the government drained the treasury with devastating consequences. In this context, streamlining the dysfunctional pension system is a step in right direction. But what is bizarre is the increment of retirement age to 67 years in a country where youth unemployment has reached an alarming level of 50%! 

Privatization and miscellaneous:

The final list of reforms pertain to privatization whereby steps will be initiated to privatize regional airports, ports and other assets listed under the Hellenic Republic Asset Development Fund (HRADF). Some other initiatives listed in the proposal include steps to modernize corporate and household insolvency laws, liberalize closed sectors like wholesale trade, construction, e-commerce and media, open up restricted professions like engineers, notaries, and actuaries, setup one-stop shop for business clearance, reform the gas market and initiate steps to privatize electricity transmission companies.