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At the time of writing, Greece’s negotiations with the International Monetary Fund (IMF) over its debt look in doubt, and there is the possibility that Greece may default on a €1.5 billion debt repayment installment due to be paid to the IMF on 30th June 2015. The potential default comes amid a host of long-term economic problems, which plague the country. Despite a series of bailout packages, Greece’s debt-to-GDP ratio stood at 177% in 2014, the second highest in the world after Japan. It has a cripplingly high unemployment rate at 26.6% of the economically active population in 2014, a youth unemployment rate which is the highest in the eurozone of 55.8% of the economically active youth population aged 15-24 in 2014 and a real GDP total decline of 22.0% from 2009-2014. These ongoing issues raise questions over the wisdom of continuing to burden Greece with debt while little is being done to address the underlying problems afflicting the Greek economy. In the context of a debt cycle, a default would at least allow Greece to start again.
Source: Euromonitor International from International Monetary Fund (IMF)/ International Labour Organisation (ILO)/Eurostat/national statistics/OECD
Government finances are akin to a scaled up version of personal or company finances. In the event of an individual or a company entering into financial difficulties that are so severe that they cannot reasonably ever recover from, the solution is invariably to write the debts off, entering bankruptcy or liquidation. Nobody would rationally suggest that saddling an individual or a company with ever greater debts would achieve anything other than exacerbating the problem. Doing so does nothing to address why the underlying causes of financial difficulty occurred in the first place. Yet that is exactly what has happened on a much larger scale to Greece. Its debt-to-GDP ratio has soared from 108% of its total GDP in 2008 to 177% in 2014, the highest in the EU and second highest in the world.
Greece has been consistently plagued by very poor business and consumer confidence as a result of the continued cycle of bailouts and debt restructuring. It also ranked very poorly for a developed economy in the World Bank’s Political Stability and Absence of Violence Index 2013, at 122nd place out of 203 economies. Another key issue is its overly complex taxation system, which is in real need of reform. For example, it has separate VAT rates for some of its islands, a system which is open to abuse. Greece had a very low total tax collection, at just 22.6% of its total GDP in 2014, one of the lowest in the EU. It has major problems with tax evasion, especially among self-employed workers and some companies.
The added complication of potential debt contagion to other European economies such as Italy has been one of the reasons why other eurozone members and institutions such as the European Central Bank have fought to retain Greece’s place in the eurozone by the numerous financial bailouts that Greece has entered into. Any deal between Greece and its creditors will only work if it includes a credible plan to tackle the structural problems facing the Greek economy, otherwise the ongoing debt cycle will continue. A Greek default and a potential ensuing Grexit will inevitably cause extreme chaos both to its political and business environment and consumer confidence in the short-term. Yet in the long run, a default, and end to the borrowing/ debt restructuring cycle would allow Greece to start afresh and rebuild its ailing economy.