Grexit nears as austerity bites

NYT has an excellent account of how austerity is forcing Greece ever closer to a sovereign default. Forget repaying its external creditors, the Greek government may not even be able to pay its employees and pensioners. 

Fears of a Grexit has left bond yields soaring, effectively forcing the country out of the capital markets. 

Austerity is taking its toll by way of lower aggregate demand and attendant fall in tax revenues. The Times writes that the government has not made much headway with reforming the taxation system and increasing tax collections,

Salaries and pensions in the private and the public sectors have been cut by up to 50 percent, leaving Greece 495 million euros short of its revenue targets in the four months ended in April, according to the Greek Finance Ministry. With less cash, consumers have curbed spending, leading thousands of taxpaying businesses to fail. 

Income expected from a higher, 23 percent value-added tax required by the bailout agreement has fallen short by around 800 million euros in the first four months of 2012. That is partly because cash-short businesses that were once law-abiding have started hiding money to stay afloat, tax officials said. Greece’s General Accounting Office said recently that the state collected 25 percent less revenue in May than it did a year earlier. And the state has had to slash its goal of raising 50 billion euros from privatizations to just 3 billion euros as foreign investors lose interest.

With debt-to-GDP ratio rising steadily to 165% and fiscal deficit projected at nearly 7% for 2012 Greece is clearly facing a solvency crisis. After declining by 6.9% in 2011, the Greek economy is expected to continue the same trend, albeit contracting annually by 4-5% for 2012 and 2013. In the circumstances, Greece immediately needs both massive fiscal transfers as budgetary support and low cost loans from the ECB, and that too for a sustained period of time. And even with this, the issue of regaining competitiveness will remain unresolved.