Saving Greece: Athens is counting on Angela Merkel to save the day by Shawn Tully @FortuneMagazine June 5, 2015, 1:48 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons The chasm between the reforms the Greek government is willing to make and the far stricter measures demanded by its European creditors now appears unbridgeable. It’s highly unlikely that Athens’ far-left leaders and the cast of central bankers, finance ministers, and analysts across the table will find the necessary common ground on pensions, taxes, and labor liberalization required to forge a deal by the effective deadline, which is slated for mid-June. The current standoff comes as anything but a surprise to Greek prime minister Alexis Tsipras, and his finance chief Yanis Varoufakis. It’s clear that practically from the start of negotiations three months ago, they’ve been counting not on convincing ministers and bureaucrats, but rather on a minute-to-midnight intervention by Europe’s most powerful heads of state, led by Angela Merkel of Germany. On June 3, Tsipras issued a harsh statement, charging that “the political leadership of Europe needs to accede to the realism the Greek government has been adhering to,” and adding, “I’m confident that the political leadership of Europe will do what needs to be done.” The operative word here is political. Tsipras and Varoufakis believe that, faced with a Grexit, Merkel will overrule her finance minister and convince her peers to follow suit, forcing the European authorities to accept most of what appears to be Greece’s final offer. “It’s hard to see any way out except intervention at the highest levels,” says economist James Galbraith, a professor at the University of Texas and a former colleague of Varoufakis’. Hence, Tsipras is focusing his campaign not on policy details but on lobbying the ultimate decision makers. On the evening of June 5, he held talks with the team whose support he urgently needs, Merkel and French President Francois Hollande. During the week of June 1, the world got the clearest view yet of the gulf between the lenders’ position and that of the Greek government. Late on Monday evening, Athens presented its plan, which it more or less labeled as its final offer. Then on Monday evening, Merkel and Hollande met with the IMF, the European Central Bank, and European Union officials to unite on a common set of demands. On Wednesday, Greece’s creditors handed Athens their list of requirements, widely viewed as a “take-it, or leave-it” salvo. Comparing the two documents, point by point, reveals that the differences have narrowed. Still, the dueling proposals contain demands and counter-proposals that are far too at odds to resolve quickly, if at all. The EU document, entitled “Greece–Policy Commitments,” is just four-and-a-half pages long and is extremely general. By contrast, the Greek manifesto––“Agreement on the Economic Policy, the Reforms of the period 7/2015-3/20015,” covers far more specifics and runs at over 47 pages. The crucial issue of Greece’s “primary surplus” epitomizes the problem. Both sides have compromised, but their numbers are still far apart and would require sharply divergent policies to achieve. Primary surplus represents the surplus of revenues over expenditures, excluding interest payments on debt. Right now, Greece is running a primary deficit of around two-thirds of 1% of GDP, coming to about $1.6 billion on national income of $240 billion. Greece’s lenders—the EU, ECB and European Union—demand that the troubled nation run a surplus of 1% this year, rising to 3.5% by 2018. That’s well below the lenders’ previous requirement of 3.5% in 2015, rising to 4.5% the following year. But it’s far above the numbers Greece is proposing: 0.6% in 2015, increasing to 3.5% in 2018. “It’s hard to see how the lenders’ numbers can be achieved without strong growth in the short-term,” says Galbraith, a scenario that’s unlikely. In short, embracing the creditors’ demands would require bigger tax increases and spending cuts than Athens is willing to make. A second, and related, issue is value added taxes. Today, Greece imposes a wide variety of rates under its VAT (value added tax). The lenders want the government to winnow the system down to two rates of 23% and 11%, the latter for essentials like food and medicine. The creditors are requiring that Greece raise an extra 1% of GDP, or around $2.4 billion a year, by flattening, and effectively raising, the rates. In its proposal, the Tsipras government proposes replacing the current hodgepodge with three rates of 6%, 11%, and 23%. But it’s also refusing to increase taxes on crucial products and services, including its citizens’ electrical bills. The EU proposal would raise electricity levies by around 10 percentage points, which may be a potential deal-breaker for the Greeks. It’s also unclear how much money the Greeks expect to collect from the revamped VAT. In its presentation, the revenue line is left blank. Athens does propose raising well over $1 billion a year from a new tax on the profits of big companies. It’s also unclear if the lenders approve of this proposal. It might be viewed as a barrier to foreign investment, a crucial lever for future growth. The most divisive issue is pensions. The lenders are demanding that outlays for retirees be lowered by as much as 0.5% of GDP this year, and 1% in 2016. Those are big numbers. In its document, Athens recognizes that pensions must be reformed. The current system invites abuse, particularly from workers in Greece’s sizable banking sector. The Greek government has agreed to gradually raise the retirement age. But the savings aren’t nearly as big as the creditors want. They amount to just $80 million this year, and will rise to $700 million by 2022. That’s a fraction of the $2 billion-plus the lenders are demanding for next year alone. The Greek leaders, for example, are adamantly opposed to demands that they lower pensions as much as 30% to folks receiving benefits of $400 a month. The two sides have also drawn closer on the matter of privatization of government assets and institutions. But once again, the lenders’ program is far more ambitious. The Tsipras government resists privatizing public utilities, especially those serving the Greek islands. “They’d be forced to sell the electrical grids at fire-sale prices, and the government would be replaced by a monopoly,” says Galbraith. “The government’s position is, ‘Talk to us when the economy comes back.’” All told, the EU and its partners are insisting that the Greeks follow the original requirement to raise $25 billion from privatization by 2022. In its proposal, Athens predicts garnering just $12 billion from selling government enterprises––including the ports of Thessaloniki and Piraeus––by 2020. Greece’s plan also proposes new social programs. For example, the government plans to stop the auctioning of foreclosed houses and allow low-income Greeks to replace mortgage payments with lower amounts based on a percentage of their income, and hence remain in their homes. That would require new federal subsidies, so it’s uncertain if the lenders will endorse or reject the proposal. For their part, the creditors have dropped demands that Greece fire government workers. They now want federal payrolls to shrink, year after year, as a portion of GDP. The Greek document makes no reference to capping spending on government employees. The deadline for a deal is June 30, when Greece’s bailout period officially ends. But a more realistic date is around June 15, since parliaments of its EU neighbors must approve the deal to unlock $8.1 billion in aid, a tranche that’s already been delayed for a year. Wolfgang Schaeuble, the German finance minister, is a hard-liner who wants the Eurozone to comprise of well-functioning economies that follow fiscal probity. He’s unlikely to bend to Greece’s demands. But his boss, Angela Merkel, must think on a grander scale. And the historic decision of whether to keep Greece in the club may be hers alone. Judging from her previous moves, Merkel will make peace, or side with the hard-liners, only hours before the deadline. Tsipras has long been betting that what he considers statesmanship will trump the quibbles over pensions and VATs. We’ll soon see if he’s read Merkel correctly, or if he has made a miscalculation that will drive the already-wobbling Eurozone into uncharted territory.