Greece's drastic austerity measures aimed at solving its massive sovereign debt problem led to a demonstration of more than 100,000 people this week in which three were killed.
Greece, a member of the European Union, is awaiting final approval for a three-year 110-billion-euro bail-out package from other European countries and the International Monetary Fund.
With its sovereign debts amounting to more than 100 per cent of its GDP, Greece has become bankrupt, and is now subject to the tough austerity measures mandated by the IMF. These measures include salary and pension cuts in the public sector as well as tax increases.
According to a Citibank report, the package requires the Greek government to cut spending and increase taxes to the tune of 30 billion euros, accounting for 12.5 per cent of the nation's 2009 GDP.
With a five-percentage-points-of-GDP tightening in 2010 and another four-percentage-points-of-GDP tightening in 2011, the economy will contract sharply by 3-4 per cent this year and another 1-2 per cent in 2011.
The budget deficit is now projected to fall below 3 per cent of GDP by 2014, a year later than projected under Greece's EU stability programme agreed last January.
In terms of debt financing, the 110-billion-euro package is just enough for the next three years as the remaining sovereign debt financing requirements for the rest of 2010 are about 30 billion euros, while those for 2011 and 2012 are 40 billion euros each. In other words, the package will just postpone the restructuring of massive debts, with a significant haircut for creditors.
Details of the 110-billion-euro package show that 80 billion euros will come from Euro-Area (EA) nations while the remaining 30 billion euros will be provided by the IMF.
The EA loans are charged at a rate of 300 basis points over the swap rate for loans of up to 3 years' maturity, and 400 basis points over the swap rate for longer maturities.
The EA member state loans will not be more senior than the existing sovereign debt so the amounts will be shared in any haircut that may be applied during a restructuring.
Regarding the IMF, it has asserted a "preferred creditor status", so its loans are always senior to those of any other creditor.
According to the Citibank report, if the fiscal tightening is implemented, and if the Greek economy does not contract more severely than expected, the government's gross debt will reach 145-150 per cent of GDP by 2013.
Interest expenses alone will be around 7 per cent of GDP whereas the current primary deficit is around 9-10 per cent of GDP.
To cover its obligations, Greece will need a nominal GDP growth of at least 3.7 per cent over the next few years. Such a performance may be achievable if the Euro-Area monetary policy is not too tight.
However, the immediate pains resulting from drastic austerity measures cannot be under-estimated. During the 1997-98 Asian crisis, several countries, including Thailand, Malaysia and Indonesia, were hit hard. In Thailand, the US$17-billion IMF bail-out package led to a sharp GDP contraction, as much as 10 per cent on the following year. In Indonesia, drastic austerity measures led to riots and domestic food shortages as well as the downfall of then-president Suharto.
So good luck Greece.