By Barry Norris
The confrontational scenario between the Syrizia-led Greek government and its creditors is coming to a head: Greece does not have access to funds to meet the €2bn of IMF funding due to be repaid in June and July and the €6.5bn of government bonds scheduled for redemption in July and August. Unless a third bail-out programme can be agreed upon, Greece will default, with the only question being whether this happens in June or July.
While most market participants view a last minute deal that avoids default as the most probable outcome, the Syrizia government might believe a face-saving deal with creditors is more probable after a default. Any Greek default would, however, likely be Syrizia’s final act of brinksmanship: there is a real danger Greece overplays its hand, leading to the ECB withdrawing liquidity support to the Greek banks and Greece exiting the euro. I believe this would be a tragedy for Greece, but not for the rest of Europe.
While the Troika is willing to lower the cost of interest on their Greek debt, extend maturities and allow the Greek government to target a lower primary surplus, Syrizia has failed to engage constructively over economic reform – in particular over the key issues of generous state pensions, inflexible labour markets and state privatisations. Without these concessions, a third financial assistance program (following the €110bn original bailout in May 2010 and the subsequent €130bn bailout in February 2012) would not be credible – as the Greek economy would have little chance of regaining competitiveness within the eurozone. The Troika would have little choice but to allow Greece to default as the lesser of two immanent evils.
Appeasing Syrizia would moreover establish a precedent whereby every populist political movement in Europe could proclaim the end of “austerity”, disregarding the fact Europe’s position in the global economy is dependent on its sovereign nations making often unpopular economic decisions. Without this recognition, anaemic economic growth and depressing levels of unemployment will be here to stay. The decision to release a recalcitrant Greece has repercussions for the debate over Europe’s economic future.
There will be concerns over ‘contagion’ effects of the Greek default – particularly as euro membership was previously considered inviolable. However, the longer term risks of ‘political contagion’ need to be weighed against short-term ‘financial contagion’. The euro is only credible if membership comes with inviable rules; if these rules are consistently broken, membership should be withdrawn. No other eurozone government shares Greece’s unsustainable levels of debt, nor a government without regard for the conditions of eurozone membership. The other peripheral countries have largely accepted the necessity of fiscal responsibility and a more liberal economy, which has allowed them to regain competitiveness. The double standards implied by Syrizia’s negotiating stance have not been lost on these governments, which have taken a firm line against Greek appeasement in the current negotiations.
While Greek debt default and/or exit from the euro may initially be viewed as a negative financial event, the subsequent contagion would be manageable. The Greek economy accounts for just 1.5% of the eurozone economy. Although Greece has €322bn of government debt, 78% is owned or guaranteed by eurozone governments and the ECB, which have record cheap access to capital and ability to print money respectively. The ECB would probably need to be officially “recapitalised” as a result of its exposure to Greek government bonds and its Emergency Liquidity Assistance (ELA) exposure to the Greek banks of €80bn. But even in the unlikely case there were zero recovery by creditors, or new money printing, the entire stock of Greek government debt would increase debt/GDP ratios across the eurozone by only 3%. The ECB’s QE is also now a credible backstop to prevent a sustained spike in peripheral yields, and its bond purchases could be accelerated.
Although the Greek government is running out of cash, the final roll of the dice will probably be a sovereign default. This won’t necessarily lead to a ‘Grexit’, which would only happen were the ECB to withdraw its emergency assistance from the Greek banking sector. ELA can only be provided to ‘solvent’ institutions – and if the sovereign defaults, could its commercial banks still be regarded as ‘solvent’? In this case, Greece will be forced to introduce a parallel currency and institute controls to prevent accelerated capital flight: a tragedy for Greece, but not for the rest of Europe.
Greece: goodbye and, sadly, good riddance.
Barry Norris is founding partner, Argonaut Capital, and manager of the FP Argonaut European Alpha and FP Argonaut Absolute Return funds
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