Better be second-time lucky

Greece: Greece mustn’t waste its second chance. Athens looks like it will receive enough bailout cash to see it through to end-2013. But if it veers off track again, as is all too possible, any third chance might come with such extreme conditions that a messy default and a humiliating exit from the euro wouldn’t be far away.

The euro zone and International Monetary Fund are willing to provide more cash partly because the European Central Bank has scared Athens’ saviours into believing that a Greek default now would trigger a nightmarish set of domino collapses across the continent. In return, Greece has promised to raise the equivalent of 22 per cent of GDP through privatisation by 2015, as well as squeezing another 10 per cent of GDP from its fiscal deficit. There is also a plan to bail in private-sector creditors, albeit on a “voluntary” basis. That could cut the amount of new bailout money to perhaps euro 30 billion, out of a total funding hole of euro 65 billion. Even if Athens keeps to its new promises, it won't be out of woods. At the end of 2013, it will still be overloaded with debt, equivalent to around 150 per cent of GDP, and face yet another funding gap.

There are three reasons why Athens may disappoint again. First, although George Papandreou is likeable and honest, the Greek prime minister hasn't yet put in place a team able to wrestle effectively with a monstrously inefficient public sector. He needs to do this immediately. Nor has he managed adequately to carry the people with him — partly because he hasn't apologised sufficiently for his own errors and partly because corrupt politicians and tax-evaders have been slow to be punished. Second, although bank capital is being shored up as part of the new plan, liquidity is tight and depositors have been fleeing, according to bankers and government officials. The ECB has funded Greek banks to the tune of euro 95 billion. But it is trying to get them to reduce their borrowing in the medium term — a process hardly calculated to keep credit flowing through the economy.

Finally, the fiscal squeeze will put a brake on the economy. The next instalment, equivalent to 2.8 per cent of GDP, will be crammed into the second half of this year. That’s 5.6 per cent of GDP on an annualised basis. Exports are already picking up as unit labour costs fall; and there are high hopes for tourism, partly because people are being diverted by the Arab Spring from North Africa to the Mediterranean’s other coast for their holidays. Still, it is touch and go whether Greece can really stop its recession by year-end as envisaged under the troika's old plan. And, without growth, its promises could easily fall by the wayside.

If Athens flunks it, its saviours will have to decide whether to keep providing cash as each quarterly tranche comes due. Their willingness to play hardball will largely depend on whether they now put strong firewalls between Greece and other countries. It would be criminally foolish not to. In such a situation, Athens might still be given a last chance. But the conditions imposed might be so tough that Greece would feel it was being turned into a protectorate, with outsiders running the machinery of government and imposing yet more austerity. At that point, the already febrile Greek public might revolt. And, if the threat to cut Athens loose was really credible, a messy default would follow and the country might feel its only way of saving its banking system was to reintroduce the drachma.

The governor of the Greek central bank, George Provopoulos, recently said that the government should over-deliver on its promises. Papandreou should heed his advice. If he falls behind the curve again, history will damn him.