Greece—Once Again on the Edge
Greece is again on the precipice of an economic crisis after the Syriza-led government managed to push all potential (non-blogosphere) allies into de facto adopting the German negotiating position enunciated by Finance Minister Wolfgang Schäuble: There will be no more money for Greece unless it continues the previously agreed structural economic reforms, pursues credible fiscal policies, and accepts ongoing external economic surveillance.
As discussed previously, Greece needs a deal to avoid another economic blow resulting from a failure to pay one of its official sector creditors. The pain from such a crisis will fall almost entirely on Greece itself, giving Syriza virtually no political leverage in the negotiations. The rest of the euro area has been immunized by the improvement in its economic performance, as well as institutional improvements (especially the European Stability Mechanism and the Single Supervisory Mechanism for banks), not to mention the ongoing asset purchases by the European Central Bank (ECB).1 These steps have substantially reduced the risk of material cross-border financial contagion from Greece to other euro area members. It is in other words not 2011 anymore in the euro area.
Since rumors of early Greek elections began in late 2014, the country’s deficit position has deteriorated to what is probably by now a de facto primary deficit, which only a large runup in arrears to government suppliers has prevented from becoming official. Thus even if Athens follows through on its pledge to make pension and wage payments a priority over paying its creditors, there would still not be enough money to pay all of Greece’s bills.2. As such, the “political seniority” rhetorically bestowed by Syriza on domestic creditors in Greece at the expense of official sector creditors is a myth.
In addition, the large arrears owed to domestic suppliers and the confiscation of surplus cash from other parts of the government, including localities with their own democratic mandates, makes a mockery of Athens’s alleged “anti-austerity” stand. Not paying domestic suppliers is a cynical backdoor form of austerity that produces sequester-style high fiscal multiplier cuts more shortsighted than any fiscal cuts demanded by the creditors.
Among those to whom Syriza will default on payments even after defaulting on its debts to the Troika (the European Commission, the ECB, and the International Monetary Fund [IMF]—now known as “the institutions”) are its core political supporters—public sector workers and retirees. It is thus doubtful that the government can survive such a step. Until now, it may have been rational for such groups to support Syriza’s policies, shielded as they are from the impact of Syriza’s confrontational stance with the Troika. But if the official sector creditors aren’t paid, deepening economic crisis will quickly see politics in Greece change dramatically against Syriza.
It makes little sense for a country making up just 1.8 percent of euro area GDP—meaning the equivalent of Greece’s economy will basically be added to the euro area economy in 2015, if current growth forecasts for 2015 prove correct—to command such an exorbitant number of international economic news headlines. Financial markets seem to know better. They have taken developments in their stride. This calm and lack of contagion effects are likely to continue.
Two near-term scenarios can be sketched out for Greece, neither resulting in a Grexit and hence not threatening the region’s economy.3
The Cooperative Scenario Here the Greek government belatedly realizes its hopeless situation and finally succumbs to reality at 2 minutes to midnight (i.e., in the next couple weeks) by agreeing to perhaps 90 percent of Troika demands. The Troika would—sensibly in light of the deteriorating macroeconomic situation—agree to lower the fiscal target for Greece and reconfirm its commitment to further restructuring of euro area debt in the future, when political trust has been restored, a process that could take several years. The Greek government would have to go along with structural reform demands, including crucially (and to date opposed by Syriza) further pension and labor market reforms as part of this scenario.
Greek Prime Minister Alexis Tsipras would face no problem in securing a large parliamentary majority for such a deal despite possible defections from his own party’s left-wing. Creditors, however, should not give special consideration to political ramblings inside the Syriza governing coalition. A straight-up vote in the full parliament—representing the totality of the Greek people’s democratic mandate from January 2015—for any deal should be demanded.
Such a deal would likely see all official sector creditors paid on time and provide for a calmer political and financial market in Europe this summer, until negotiations about Greece’s longer-term relationship with the euro area start in the fall.
The Noncooperative Scenario A rejection of Troika demands, resulting in missed payments to official sector creditors—at the very latest the first large payment to the ECB in July—would accelerate deposit outflows from Greek banks. The ECB would in turn probably stop or curtail emergency loans to Greek banks. Rather than pull the trigger themselves, authorities at the ECB in Frankfurt would first request a fiscal guarantee from the euro area to continue the emergency loan authority (ELA) provision. The Eurogroup finance ministers would say no, freeing the ECB from the political responsibility for cutting off the Greek banks. Without ELA, Greek banks would impose controls on access to deposits, or perhaps an outright indefinite bank holiday, sending the Greek economy into a tailspin.
In theory, the Greek government could issue IOUs or scrip in this scenario, but such a step would hardly be welcome among its citizens, a large majority of whom continues to favor euro membership and would likely reject parallel currencies. IOUs or scrip would consequently decline in value and stoke inflation along with further economic decline.
Syriza’s political platform of ending the Troika, austerity, and structural economic reforms without adverse consequences was always unrealistic if not deceitful. Pushing ahead with current policies, as described above, would cause a collapse in political support for the government, bringing about the need for a new political mandate for engaging with the creditors in Athens. Such a development might mean new elections (which could take four weeks), a referendum on the Troika demands (which could be done in a couple of weeks) or merely an open vote in the current Greek parliament, where a majority would surely be found quickly in these much more dire economic circumstances. Cynical observers of Syriza might conclude that the latter option has been Alexis Tsipras’s plan all along: to foment this kind economic emergency in Greece to legitimize his political U-turn, thus despite his revolutionary rhetoric to date enabling himself to stay in power also after a deal is struck with the Troika.
The noncooperative scenario thus ultimately ends up with a similar result—a deal struck with the Troika, though only after additional economic damage has been imposed on the Greek economy.
Which of the two scenarios will it be? The benign scenario should of course have been adopted months ago. At that time, Syriza might have gotten a decent deal from the euro area. Instead, a destructive and futile confrontation has reduced nominal GDP by more than €3 billion in 2014 compared to the latest available mid-2014 pre-Syriza IMF projections4 and look set to cost Greece—in the improbably optimistic scenario that Greek GDP will not decline further in Q2-Q4 2015—another almost €10 billion relative to pre-Syriza takeover forecasts in 2015. That loss implies a loss of more than €1,000 per capita cost in GDP terms for each of the 11 million Greek policies in 2014–15. Syriza’s policy failure can be measured by the fact that the looser fiscal target—such as a primary surplus target of 1 to 1.5 percent of GDP—would have delivered a huge political victory for them a few months ago. Because they rejected that arrangement, the economy has probably deteriorated so much that additional austerity will today be required to meet such a looser fiscal target.
The probability of Syriza stepping back from the brink and changing policies at the last minute is not much more than 50 to 60 percent. With just days to go before Greece runs out of money, the new Troika strategy of first agreeing among themselves on a final proposal and then presenting it as a final take-it-or-leave-it-but-you-bear-the-consequences offer to the Greek government is an appropriate way to focus minds in Athens.
While still not the baseline scenario, there consequently remains a large risk that in the noncooperative scenario another bout of acute economic crisis will be required for Greece’s current government to make the necessary policy adjustments. This would be yet another act of the Greek tragedy, but perhaps not too surprising with a party like Syriza leading the government. After all, what should one expect from a self-professed so-called radical left party, which nonetheless has no women among the 10 ministers in the government it leads and whose all-male cabinet (excluding the youthful prime minister) has an—surely the highest in the EU—average age over 61 years of age?
¹ As noted earlier here on RT, the timing of the ECB’s expanded asset purchase program coinciding with the current showdown over Greece has undoubtedly facilitated the mute resistance to the ECB’s policies among many traditional opponents of sovereign bond purchases in Germany and elsewhere. In the end, the ECB’s program had been grudgingly accepted also because of the political convenience it offers in terms of removing the risk of any cross-border bond market contagion from the Greek situation.
² This is true even in a highly conservative, no deterioration scenario. In reality, the further economic deterioration likely in Greece following a potential nonpayment to the official sector would further reduce government revenues and the ability to service domestic Greek creditors.
³ Even if in a less than 2 percent probability tail-end risk scenario, were a Grexit still to materialize, the short-term financial market repercussions outside of Greece would probably be limited. A Grexit would instead pose a substantial headache for the ECB’s eventual exit from quantitative easing, as redenomination risk would suddenly be priced in with a potential vengeance. Similarly, a Grexit would result in such a political and economic catastrophe in Greece that it would undermine attempts at securing public support around the European Union for future changes to the EU Treaty.
⁴ See the fifth IMF review of the Greek program [PDF] in June 2014.