As Greece's Bailout Moves Forward, Significant Hurdles Remain

  • Bailout auditors set to resume negotiations in Athens
  • Government to legislate IMF-backed structural reforms

Greek bond yields plunged to the lowest level in almost a month after creditors reached an agreement that would allow auditors of the nation’s bailout to continue negotiations for the release of another emergency loan payment.

The yield on two-year notes fell 130 basis to 8.17 percent on Tuesday amid expectations that the latest chapter of the Greek drama will have a happy ending. And even though Athens doesn’t have another big debt payment until July, the country will have to overcome several high hurdles before then. Here’s an explainer of what happened at a meeting on Monday of euro-area finance ministers, and what still needs to be done so that expectations can turn to reality:

What Has Changed?

After Monday night’s meeting, the Greek government agreed to legislate structural reforms demanded by the International Monetary Fund that will lower the threshold of tax-free income and amend the pension system. These changes will come into effect by 2019. Until now, such measures were a red line Prime Minister Alexis Tsipras had said he wouldn’t cross. Its color has now faded.

The reforms will act as reassurance for the IMF that Greece can meet the euro area’s budget surplus target of 3.5 percent of gross domestic product before accounting for interest payments. If Greece beats this goal, the policies will still be implemented, but compensatory measures, such as tax cuts for companies and higher-income earners, will kick in to offset the over-performance and stimulate the economy.

Is This The End of Austerity?

The agreement addresses an IMF concern that a large part of the middle class is exempt from paying income tax while companies are overburdened by excessive duties, damping economic activity. The new agreement seeks to change the fiscal policy mix to what the IMF says is a sustainable path without changing the overall target for a 3.5 percent budget surplus.

The government says the deal won’t increase austerity since the new legislation will include stimulus measures in addition to the tightening reforms. One caveat is that the compensatory measures won’t kick in if the government falls short of the 3.5 percent surplus target.

Another caveat is the deal doesn’t allow the government to spend additional funds from over-performance on any policies it chooses; the stimulus measures will have to be agreed in advance. Last year, Tsipras’s move to distribute a one-off Christmas benefit to pensioners triggered a backlash from creditors, who temporarily halted debt relief operations for Greece.

Is This a Done Deal?

Euro-area finance ministers and the IMF said that while the agreement signals progress, there’s still a lot of work that needs to be done. The exact size of the additional package and the specific reform measures will be decided when bailout auditors return to Athens, where they’ll also examine the latest budget data.

After the two sides reach a so-called staff-level-agreement on what needs to be done, the finance ministers will then discuss additional debt relief measures, which are being demanded by the IMF as a condition to participate in the Greek bailout. The Washington-based fund is likely to ask for a more concrete description of the “medium-term” instruments that will be adopted after 2018 to ensure that Greece’s obligations returns to a sustainable path.

While these instruments will be contingent on debt sustainability analyses that will take place at the end of the current Greek support program, and won’t include a nominal haircut on bailout loans, the debate is likely to prove contentious. Many euro-area countries have disputed the need for further easing of the repayment terms on Greek bailout loans, and the IMF may insist that it gets more than another vague commitment of support. The European Central Bank has also said it won’t include Greek government bonds in its asset purchase program before these “medium-term” measures are in place.

What About the IMF?

Agreement on debt relief measures could prove as complicated as agreement on Greece’s fiscal policies. Once both fall into place, IMF staff will propose that the fund’s executive board approve a new Greek bailout program. The program could run until August 2018 when the latest European bailout is set to expire, with the hope that Greece will have regained independent market access by then.

The scope of debt relief needed largely depends on the assumption about Greece’s future budget performance. Both the IMF and the Greek government push for the primary surplus target to be lowered from 3.5 percent as soon as possible after 2018. Euro-area governments disagree, as less ambitious fiscal targets mean that more debt relief will be needed.

When Will Greece Get More Aid?

In the meantime, the Greek parliament will have to approve all the prior actions tied to the latest review before any money is disbursed. In addition to fiscal policies, the measures include an overhaul of labor market rules, a new out-of-court debt settlement framework, and several other conditions, which in the past have proved contentious for governing coalition lawmakers.

If things move fast, the entire process can be completed sometime in March or April, right around when the Dutch head to a national election. If not, things could drag longer, especially since Greece doesn’t have immediate liquidity constraints.

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