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Greek deal to cut spending does not end debt drama

The flags of Greece, right, and European Union flutter from the roof of the Finance Minister at Athens' main Syntagma square, as in the background is seen the ancient Parthenon temple during in Athens on Thursday Feb, 9, 2012. Greek Prime Minister Lucas Papademos and his coalition partners have struck a deal on new cuts demanded by creditors to secure a vital euro130 billion bailout. (AP Photo.Dimitri Messinis)

Greek Prime Minister Loukas Papademos,center, leader of the Socialist Party PASOK George Papandreou, right, leader of the conservative Party New Democracy Antonis Samaras, 2nd left and the leader of the right wing LAOS party George Karadjaferis enter the meeting room at Maximos mansion in Athens on Wednesday Feb.8, 2012. After three days of delays, Greek coalition leaders began crucial debt talks Wednesday with the prime minister to review a draft deal on steep cutbacks demanded by creditors in return for a 130 billion euro ($170 billion) bailout. (AP Photo/Orestis Panagiotou-pool)

The flags of Greece, 2nd left, and European Union flutter from the roof of the Finance Minister at Athens' main Syntagma square, as in the background is seen the ancient Parthenon temple during in Athens on Thursday Feb, 9, 2012. Greece's deputy labor minister has resigned to protest demanded new austerity measures. Yiannis Koutsoukos issued a statement on Thursday saying he opposes implementation of cutbacks and reforms agreed earlier Thursday to secure the country's international rescue loan lifeline. Koutsoukos is a lawmaker with the majority Socialist party. (AP Photo/Dimitris Messinis)

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By DAVID McHUGH, The Associated Press Updated 9:01 PM Thursday, February 9, 2012

FRANKFURT, Germany — More than two years after it came clean about its addiction to debt, Greece may finally have begun its long and painful road to recovery.

Greece's fractious political leaders struck a deal Thursday to make deep cuts in government jobs and spending to help save the country from a default that could shock the world financial system.

The deal, under negotiation since July, is one of two critical steps Greece must take to receive a €130 billion ($170 billion) bailout from other countries in Europe and around the globe.

European ministers said the deal needs to go further and gave Greece until the middle of next week to find an extra €325 million ($430 million) in savings, pass the cuts through a divided parliament, and get written guarantees that they will be implemented even after elections set for April. Greece is expected to rush the new austerity measures through parliament by late Sunday.

In addition to the fiscal austerity mandated by the European Union, the European Central Bank and the International Monetary Fund, Greece is close to an agreement with private investors who hold nearly two-thirds of its debt to sharply reduce the country's borrowing costs.

Greece needs the bailout by March 20 so it will have enough money to redeem €14.5 billion worth of bonds coming due. If it doesn't make that payment, it will be in default. Financial analysts fear that could set off a chain reaction similar to the financial meltdown triggered by the collapse of investment bank Lehman Brothers in the fall of 2008.

The bailout will ease some of the uncertainty that has unsettled Europe and the world financial system for more than two years, but it will not bring down the curtain on Greece's debt drama.

Greece remains in a deep recession. Unemployment is 20.9 percent after the economy's fifth straight year of decline. Its government finances and its economy are being dragged down by costly political patronage, tax evasion and special protections for some favored trades.

Greece will be struggling to pay its debts for years, says Domenico Lombardi, senior fellow at the Brookings Institution. "The scope of the problems that have to be tackled in Greece are so huge and so entrenched," he says.

Efforts to fix those fundamental problems, at the behest of Greece's increasingly exasperated creditors — including prosperous Germany — are moving slowly, if at all. If they are not solved, Greece may find itself back at the edge of default.

The deal Greek political leaders struck Thursday includes a 22 percent cut in the monthly minimum wage to €586 ($780), layoffs for 15,000 civil servants and an end to dozens of job guarantee provisions.

Greece is also close to a vital debt-relief deal with banks, hedge funds, pension funds and other private investors. Under the tentative deal, the private investors would exchange €206 billion in Greek government bonds for €30 billion in cash, plus €70 billion in new bonds. The cash would come from the €130 billion package from Europe and the IMF. The new bonds also would have a lower average interest rate and a longer term of maturity.

The combination of less principal to repay when the bonds mature and less interest to pay every year until then means Greece would spend about 70 percent less than it would have without a deal.

The debt held by the European Central Bank and other public institutions accounts for one-third of Greece's national debt and is not part of this tentative deal. However, ECB President Mario Draghi said Thursday that the bank could distribute to member countries the profits it stands to make on Greek bonds, leaving open the possibility of additional debt relief for Greece.

If Greece were to default, investors would become reluctant to lend to other heavily indebted European countries for fear they would not get their money back, pushing their borrowing costs even higher than they are now.

Those other countries include Italy, which has an economy six times the size of Greece's. Most analysts say Italy is too big to bail out.

The specter of default has hung over world financial markets for more than two years. Whenever there has been progress — and, indeed, U.S. stock indexes have doubled from the lows they reached in March 2009 — Greece has always stood in the way of more.

And while the immediate danger appears to have passed, it is far from clear whether Greece has won enough debt relief to fix its finances for good.

Its economy — ultimately the key to handling debt — remains in a deep recession. It shrank at an annual rate of 5 percent in the third quarter of 2011. Earlier in the year, it was shrinking at an 8.3 percent rate, about as fast as the United States economy was shrinking during the worst of the Great Recession. Thousands of shops and small businesses, vital to the Greek economy, have gone bankrupt. And protesters have taken to the streets of Athens regularly to denounce the government and its austerity measures.

Greece's troubles with debt go back to the 1980s, when successive governments began increasing the size of government and the number of public employees. By 2010, the total had reached 750,000 full-time employees — including 10,000 Greek Orthodox priests and 81,000 military officers — and 150,000 on part-time contracts. That was almost one in five people in the Greek labor force.

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