FRANKFURT — 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 $170 billion bailout from other countries in Europe and around the globe. It was announced by Greek Prime Minister Lucas Papademos' office and will be scrutinized during talks in Brussels between finance ministers from the 17 countries that use the euro.
German Finance Minister Wolfgang Schaeuble said no final agreement unleashing the bailout money would be reached Thursday. He said more work had to be done to fulfill the conditions for a bailout.
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 $19.2 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 $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 $273.7 billion in Greek government bonds for $40 billion in cash, plus $93 billion in new bonds. The cash would come from the $172.7 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.
Government jobs became a way of rewarding supporters of Greece's two main political parties. The parties made matters worse by raising the wages of government employees to unsustainable levels. At the same time, the government was lax about collecting taxes. It had to issue ever more debt to cover its spiraling wage bills.
At first, bond investors lent freely, at interest rates slightly higher than for economic powerhouse Germany. After all, Greece was one of the 17 countries that use the euro. All had promised to observe strict budget and deficit limits. And while on paper the treaty that created the 27-country European Union forbade bailouts, there was a vague sense that Europe could not let a country go bust.
Then came Oct. 21, 2009. A newly elected government in Athens told its European partners that its finances were far worse than the previous government had disclosed.
The national deficit, the difference between what a government takes in and what it spends, was not 3.7 percent of annual economic output, as had been believed. It was 12.5 percent, and that was later revised higher to 15.4 percent. One condition of being in the eurozone was that countries were required to keep deficits to a manageable level of no more than 3 percent of economic output.
Investors around the world, still reeling from the collapse of Lehman Brothers and the worldwide financial crisis just a year earlier, began looking hard at risk. They demanded higher interest rates to loan Greece money by buying its bonds, and Greece's borrowing costs soared.
On April 27, 2010, ratings agency Standard & Poor's downgraded Greek bonds to junk status — the first time a eurozone country was given a non-investment grade rating.
The next month, other euro countries and the IMF intervened. They promised $146.7 billion in loans — to be paid out in stages — so that Greece could pay its debts as they came due.Comment on this story
The terms of the bailout were harsh: higher taxes and deep cuts in public spending and wages at least through 2020, a package of fiscal belt-tightening known as austerity. As it took hold, the Greek economy sagged further, and it's expected to remain weak for years.
The second $172.7 billion bailout package would come as loans plus $39.8 billion in cash that would go to the private creditors who agree to swap their bonds. Greece would use an additional euro40 billion of the bailout money to invest in the country's banks, which stand to take massive losses as part of the debt-relief deal.