Greece: The Unvarnished Truth

A series of weekend polls in Greece showed some movement in the electorate and put the New Democracy ahead of Syrzia. This is important because which ever party comes in first gets an extra 50 seats in the 300-seat chamber. The polls suggest the New Democracy and PASOK could retain the reins of government.

Yet a false dilemma has been presented. It is most assuredly not Schaeuble's way or the highway. It is not a choice of austerity or leaving monetary union. It is not adherence to the memorandum of understanding or being isolated in Europe.

The fact of the matter is even if New Democracy's Samaras becomes the next prime minister of Greece the terms of its aid must and therefore will be renegotiated. Two recent reports confirm that Greece's trajectory is well off the agreed path.

First, tourist revenues fell 15% year-over-year in Q1 and the news appears even worse in Q2. The controversy following the election saw 50,000 booking canceled, according to press reports. Some are estimating that Q2 tourist revenues may have fallen 20%. Tourism accounts for almost a fifth of Greece's economy.

Second, tax revenue fell 10% in May. This is not simply a function of tax avoidance, but it also reflects the imploding economy. In 2011, some 20% Greece's small and medium sized businesses lost money. This year estimates suggest as much as 60% will lose money.

The memorandum of understanding assumed that more efficient tax gathering efforts would boost revenue. It also assumed tourist revenues would be flat. On both counts, terms need to be adjusted.

Although Tsipras' style may be objectionable, his underlying argument seems correct. Greek officials have played their weak hand poorly. This seems even more true following the PSI that halved the holdings of the private sector. The official sector refused to participate, which, while understandable, complicates the situation.

It means that almost three quarters of the debt Greece owes is to the official sector--ECB, IMF and EU. A unilateral moratorium, which Tsipras reportedly threatened, would hit the Troika hard. The ECB would likely need to be recapitalized. The IMF would find it more difficult to raise fresh funds. The EU would be ridiculed as well as poorer.

Yet it is also true that any effort to reduce Greece's debt burden going forward must focus on the official sector. Of course, a fallout from a Greek exit and a moratorium on its debt servicing would hurt European banks and sovereigns; some due to direct exposure, others indirectly.

One recent poll had nearly two-thirds of Germans opposing keeping Greece in the monetary union. Officials there do have not done a sufficient job explaining the costs Germany would incur if Greece left. Germany frankly does not have a choice of washing its hands of Greece and not putting in good money after bad.

The unvarnished truth is that Greece is going to cost Germany (and others) whether it is in EMU or not. The unvarnished truth is that the decision not to allow Greece a proper default (which would have included the official sector) means it is still not on a sustainable fiscal path. The unvarnished truth is that even if the old elite in Greece is able to put together a new government, its memorandum of understanding needs to be re-crafted.