In early February 2022 - remember back then when inflation was still our principal concern - the ECB signaled a hawkish turn on monetary policy. What happened next? Italian and Greek debt sold off and their 10-year yields popped. It wasn’t a crisis by any means, but the tremor was significant enough to set nerves twitching. The last thing Europe needs right now is a new sovereign debt crisis.
The current macroeconomic climate makes this a pretty scary moment for Greece.
The covid crisis was a current account shock as tourism was practically wiped out. Thanks to inflation and the rising price of Greece’s energy imports, the deficit didn’t really shrink much after people start to take foreign vacations again. But if the current account deficit doesn’t shrink substantially soon, then either fiscal policy needs to stay looser for longer, or the private sector borrowing needs to do more lifting by taking on more debt.
But the former requires political support from official-sector creditors, and the mood music there is currently more about the need for Greece to start tightening soon. Rising yields are making people nervous about the debt again — this could impact real economic activity as “fragmentation” (in ECB speak) gums up the transmission mechanism.
A private sector credit boom seems unlikely given the reticence of banks to lend at such a scale. This was the case even before monetary conditions tightened — and its hard to see Greece experiencing a localised pocket of easing liquidity as things get tighter everywhere else. Even if credit did expand on a huge scale, the implications of that for financial stability don’t bear thinking about for too long.
This brings us back to the current account. If financial flows — whether to the public or to the private sector — can’t support the current account deficit at its current level, then the likelihood is that the gap will close through import compression. In other words, a recession. This is how Greece brought its external sector into balance during the crisis decade.
Greece will not be the last EU country to be put on a half century long payment plan.