Greece – Copout still more likely than Bailout or Burnout
Events in the past 48 hours have reinforced my long-held view that a copout – whereby the Troika grants the Greek government new loans in exchange for agreeing to strict reforms – is more likely than a full bailout (including significant debt forgiveness) or burnout (Greece defaults and leaves the eurozone). See Greece Lightening (28 January 2015) and Half-Time: Pass the smelling salts (3 July 2015).
Three developments in particular suggest to me that we are closer to some kind of agreement:
- Referendum outcome: The emphatic no-vote at Sunday’s referendum gives some weight to the Greek government’s position that aggressive Troika demands could result in Greece defaulting and leaving the eurozone.
- Personnel changes: Finance Minister Varoufakis’ unexpected resignation potentially removes a stumbling block to negotiations between the Greek government and its creditors. Varoufakis had held a hard stance and clashed with Troika policy-makers. He is replaced by Euclid Tsakalotos, formerly Greece’s Team co-ordinator and Deputy Foreign Minister for Economic Affairs. He is reportedly close to Prime Minister Tsipras and has taken a more conciliatory approach in negotiations than Varoufakis. The creditors’ stance has not softened much, with Germany maintaining a hard-line, but there are still voices in France and Italy – respectively the second and third largest eurozone economies – calling for a degree of compromise.
As I argued in Greece – Too many chefs spoil the broth (23 June 2015), this Greek drama has been as much about people as it has been about numbers and I have taken this opportunity to update Figure 1 below.
- ECB ELA cap: The European Central Bank (ECB) confirmed yesterday at its policy meeting that it had frozen the amount of Emergency Liquidity Assistance (ELA) the Greek central bank can provide to commercial banks at €89bn. It also said it had raised the haircut on the collateral (government and government backed debt) which Greek banks must post with the central bank in order to access the ELA, on the grounds that the current crisis had the cut value of this collateral. While the ECB provided no further details, in practise it makes it harder for commercial banks to access ELA even if the ECB raises the current limit of €89bn and increases the chance of a “bail-in” whereby depositors have to forfeit some of their holdings.
In any case until the ECB relaxes the current restrictions, the Greek government will have to maintain capital controls and potentially reduce the daily amount that depositors can withdraw from €60. This certainly creates a degree of urgency to proceedings, regardless of the referendum outcome.
In this “Copout” scenario, Greece’s main creditors grant the government new loans to pay back maturities/interest on existing debt, including a €3.5bn loan to the ECB which matures on 20 July. The ECB increases the limit on the ELA so that banks can be re-opened and capital controls lifted. A modest haircut on outstanding Greek debt cannot be excluded. Greece remains in the eurozone, for now at least. In exchange, the Greek government agrees to the Troika’s austerity measures and demands for structural reform. Official creditors are unlikely to be repaid any time soon even a fraction of the €320bn of Greek debt currently outstanding and the odds will remain reasonably high that this Greek saga plays itself again in the not so distant future. The economic progress which the Greek government was making prior the January elections and the slow economic turnaround in Portugal, Spain and Ireland offer a glimpse of hope.
While a copout remains my core scenario, there are two other scenarios none of which are appealing to both parties:
Scenario 2 – The “Bailout”: Greece benefits from significant debt relief, as suggested by the IMF, in exchange for the government adhering to serious fiscal and structural reforms. Creditors take a hit but Greece is given a faint chance to grow, deliver primary surpluses, tap secondary debt markets and slowly start paying back some of its outstanding debt to official creditors;
Scenario 3 – The “Burnout”: Greece defaults on the bulk if not all of its debt, leaves the eurozone, its economic growth collapses near-term and eurozone creditors are left with significant losses. In neither scenario 1 or 3 do creditors get their €320bn back, the main difference being that in scenario 3 that loss is effectively crystallized.
The relative stability in the euro and perhaps more importantly peripheral yield spreads (see Figure 3) suggests that either markets don’t believe in scenario 3 or that regardless of the outcome, contagion is contained by the ECB’s QE program and fact that official rather than private sector creditors hold the bulk of Greek debt. A third explanation is that actually the numbers are really not that big: Greek debt is equivalent to only about 2.5% of the eurozone’s GDP – to put it in perspective that’s the size of the state of Michigan’s GDP relative to the overall US GDP. While we’ve been pondering the impact of a Greek referendum, about $2 trillion – eight times Greece’s GDP – has been wiped from Chinese equities in the past week.
It is ultimately tricky to precisely ascertain what markets have priced in and with that in mind I will be conducting this week a survey on whether portfolio managers, analysts, policy-makers and finance and industry experts expect Greece to remain in the eurozone. I would kindly urge you to participate.
Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.
Fig 1 – www.olivierdesbarres.co.uk
Fig 2 – www.olivierdesbarres.co.uk
Fig 3 – www.olivierdesbarres.co.uk, www.investing.com