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Greece's Damaging Impasse



Since the elections in Greece were announced last fall, and especially after the installation of the Syriza-led government of Prime Minister Alexis Tsipras, the Greek saga has developed along expected lines. The incipient recovery that Greece was experiencing last year has ground to a halt and turned into what is very likely a new recession. The rhetoric out of Athens and Syriza's confrontation with its European partners have scared the private sector and triggered a massive capital outflow. Greece has decoupled from the recent improvement in euro area activity, as the divergent evolution of the Purchasing Managers Index shows (see figure 1).


This index reflects some serious negative trends. Greece's primary surplus—its fiscal deficit minus interest on its debt, which was a hopeful sign last year—has halved. The stock market has returned to late 2012 levels, and 10-year bonds are trading at yields well above 10 percent. The debate about the likelihood of a Grexit has returned, with betting houses showing meaningful odds of Greece exiting the euro in 2015. As of March 31, Betfair had bettors showing 2/7 odds on the question "Greece will not leave the euro in 2015," versus 15/7 odds on the question "Greece will leave the euro in 2015." Credit default swaps on Greek bonds show about a 25 percent probability of default by end 2015.

Greek depositors are voting with their money and taking their deposits out of the banking system at an accelerated pace. Figure 2 shows the evolution of Greek deposits in millions of euros (red line) and as a share of nominal GDP (blue line). Since mid-2012 Greek deposits had stabilized but now show a sudden and very scary decline (red line). The blue line is even more worrisome. Despite the continued recession during 2012–13, deposits returned to Greek banks last year after the debt writedown operation and bank recapitalization. Confidence in the Greek banking sector had been restored, at least to a large extent, and deposits as a share of GDP were returning to more normal levels. The economy was slowly normalizing. However, since the elections in late 2014 the panic has returned, crashing the ratio of deposits to GDP to the lows of 2012. This collapse cannot be attributed to a sudden change in the long-term fundamentals of the economy or its sustainability inside the euro. This collapse is due to political jitters.


Fortunately for the euro area (and unfortunately for the Greek negotiators, because it eases pressure on Europe to make concessions), there is little contagion into European assets. These assets are shielded by the powerful force of the European Central Bank's quantitative easing (QE) program. Figure 3 shows the evolution of the Greek stock market (blue line) compared to that of the European stock market (red line). While the Greek market has declined since the fall of 2014 and languishes not far from its all-time low, the European index has enjoyed one of its best quarterly appreciations on record.


These developments show the serious economic cost of the new government's protracted negotiation with Europe and the International Monetary Fund (IMF). Both the Greek government and the "Brussels Group"—the new name for the Troika of the European Commission, the European Central Bank (ECB), and the IMF—are playing accustomed roles, with the Greek government unwilling or unable politically to depart from its call for a "radical change with the past." The Greek government has engaged in excessive grandstanding and not enough pragmatism (see discussion). But there are also signs that the Greek government is moving towards marginal evolution rather than drastic revolution (as I suggested would likely be the case). Negotiations over new fiscal targets and reforms could still be agreed upon by the late April deadline, opening the door for the more important negotiations over a new program by late June. On the other hand, the "Brussels Group" has no incentive to reach an agreement until the last minute. With no market access, Greece has little negotiating power, and the ECB can manage the process by providing Emergency Liquidity Assistance (ELA) funds to avoid a disaster. The Brussels Group can afford to take its time until the program looks acceptable.

It looks scary from the outside, and accidents can never be ruled out, but unfortunately brinkmanship may be necessary. Deadlines are not set in stone, and funding crunches can be solved politically. In negotiations, extreme statements and threats should not be taken literally. Both parties know that no amount of preparations could prevent with certainty a disaster upon Grexit, as it is an event for which there is no precedent. The disaster that followed Lehman's collapse, despite the many months of preparations by the US authorities, is a sobering example.

Politics argue for a delay, but economics argue for hurrying up. The longer the process takes, the more damage is done to the Greek economy and the weaker the starting point of a new program.

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