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Greece's Latest Travails Are Not Europe's Problem This Time



The failure of Prime Minister Antonis Samaras to assemble enough votes to install a new Greek president has resulted in a call for elections for January 25. This worrisome development reflects Samaras's inability to articulate a political strategy beyond the narrow one of saving his own coalition of only 155 out of 300 members of parliament. But his difficulties have ushered in a period of grave political and economic uncertainty. The main opposition left-wing Syriza party is narrowly ahead in the polls, tapping into public impatience with its demand to European leaders to renegotiate the tough terms of the 2012 rescue package for Greece.

No party looks likely to win an absolute majority. If that happens, Greece's two largest parties (the incumbent New Democracy and Syriza) will have to share power with other parties, including likely some entirely new parties expected to emerge.

The latest act of the on-off Greek drama brings two aspects into focus.

First, the good news for Europe and the rest of the world: The euro area has more robust crisis management institutions than it had during Greece's last bout of political instability in 2012. These include the European Stability Mechanism (ESM), the outright monetary transactions (OMT) of the European Central Bank (ECB), and a banking union. As a result the Greek upheaval, despite sending Greek equity and bond markets into a downturn, has produced no contagion to asset markets in other euro area countries. Moreover, the ECB seems destined to launch a new and more aggressive quantitative easing (QE) program, including purchases of sovereign bonds, if euro area headline inflation dips further because of the decline in global energy prices. This step is likely to strengthen euro area stability, even though Greek assets and especially Greek government bonds will almost certainly not be included in such purchases. There is thus no reason to expect financial contagion from Greece even if the Greek crisis deepens.

A second factor dampening the prospects for Europe easing up on Greece is politics. Planned elections in some euro area countries, including Estonia and Finland in March and April, make it unlikely that they will favor further aid or concessions to Athens, for example. In addition, the governments in Spain and Portugal, which face voters and populist challenges toward the end of 2015, will also avoid easing up on Greece, as Syriza demands, when their own populations continue to endure austerity measures. Germany's finance minister, Wolfgang Schäuble, will therefore have allies when he states that "every new government must respect the agreements made by its predecessors. " Accordingly, no matter who is elected in Athens, Greece will not be able to invoke market turmoil in Europe in getting its austerity program renegotiated. The International Monetary Fund (IMF) is also increasingly exasperated with the recent lack of Greek program implementation. And at the ECB, Mario Draghi has his own political needs to placate his more hawkish members' concerns over moral hazard concerns and get them behind a new regional QE program.

Facing skeptical negotiating partners is only one of the serious obstacles facing Greece's next prime minister, however. The election sets up a compressed timetable after January 25. The two-month extension of Greece's economic adjustment program runs out at the end of February, as does the availability of the €10.9 billion in European Financial Stability Facility (EFSF) funds remaining from the recapitalization of the Greek banking system. That gives the Greek political system a month to form a new coalition government and negotiate another "technical extension" of the existing program or an entirely new program

A Perilous Situation for Greek Banks

Failure to agree on an extension or a new program for Greece would deliver several blows to the Greek economy, first in the banking system. Three of Greece's four largest banks recently failed the adverse economic scenario posed by the EU stress tests , exposing them to a cumulative capital shortfall of €8.7 billion. The Greek banks are seeking to close these shortfalls, but another severe economic downturn would make this almost impossible and provoke a crisis that Greek policymakers would be reckless to let happen.

More important is the perilous liquidity situation of the Greek banks. The expiration of Greece's aid program (granted by the troika of the ECB, the European Commission, and the IMF) would make Greek government bonds and (government-guaranteed bonds) ineligible as collateral for the ECB's regular refinancing operations. Without access to standard ECB financing and liquidity, banks would be hampered in extending credit to the Greek economy.

In previous shortages of collateral, bridge financing was available in the form of euro area credit enhancements1 or emergency liquidity assistance (ELA) by the national central bank. Such an arrangement would be feasible inside the euro area in such situations, but they would require the goodwill of euro area political leaders and/or the ECB, as a two-third majority on the governing council can block any ELA. Without a new program in place, such goodwill cannot be counted on.

Greece Has Little Leverage

Some analysts say that the Greek government will be able to exercise leverage in dealings with Europe derived from its projected primary surplus in 2015 of 3 percent of GDP (or perhaps €5 billion to €6 billion). Greece deserves credit for achieving that surplus, but Athens should not assume that it reduces Greece's dependence on its euro area and IMF partners.

The projected primary surpluses, for one thing, will not survive the adverse economic shock of an expiring troika program, which would strangle growth and reduce government revenues and reserves, jeopardizing its ability to service its debts later in 2015. Ironically, a new Greek government balking over a new troika program would force expenditure even deeper than the status quo.

The Greek government has some wiggle room. It can issue short-term treasury bills to pay its bills and debt servicing for a few months. Such a step would probably require Greek banks to purchase those bills, because few foreign buyers would be interested. Greek banks would then have to cannibalize their lending to the rest of the private Greek economy.2 Added up, these factors suggest that a defiant Greek government would renew its economic crisis.

Possible Election Scenarios

The political uncertainty surrounding the election makes predictions difficult, but several scenarios appear possible.

1. A hung parliament and no new government can be formed.

This scenario would repeat what happened on May 6, 2012, when no coalition could be formed and new elections were called again on June 17. If this happens, a second election would occur around March 1. As before, a double election would prolong and aggravate economic and financial pressures in Greece. The troika programs would expire, and its members would not be inclined to support Greece in the absence of a government.

Political uncertainty in affluent but aging societies can produce tough decisions if the economic slump is severe enough. Demands for radical action can come from youthful populations, as in the Middle East today or in Europe in the 1930s. But for Europe today, the threat of deeper economic crises is not likely to lead to radical political outcomes. Rather, electorates tend to want to preserve the perceived stability of the threatened status quo, and in the case of Europe, unlike other parts of the world, the safe haven status is the European Union. Greece has only recently exited a deep recession, moreover, and growth returned in the third quarter of last year. Greece is not likely to want to take the risk of jeopardizing its recently found economic stability.

As in 2012, Samaras will probably benefit most from a further deterioration of the economic situation. His chances of being reelected in a new election in March would be higher than on January 25.

2. Samaras's gamble works and he wins.

A Samaras victory would bring the New Democracy party the bonus of 50 parliamentary seats for the party with the most votes, enabling him to form a new majority government with one or more coalition partners—resulting in a status quo election. Should this occur, Greece can arrange a quick new program with the troika, though the negotiations would not be easy. A host of unfinished reforms from the current program remain to be implemented before any new program can be negotiated. Samaras could probably count on some limited flexibility from the troika on timing, but not content, including some form of temporary liquidity provision and debt rollovers during 2015. If Samaras can resume the reform agenda, he might be able to resurrect a transition into a precautionary ESM credit line later in 2015.

For Samaras to win, fear about the future will have to trump anger about the present among Greek swing voters. He will therefore likely stoke fears about Syriza, raise economic pressures, and paint Alexis Tsipras as a radical who would send Greece on a new downward spiral. He may also be helped in this regard by his euro area partners. The German magazine Der Spiegel recently quoted anonymous German government sources that a Greek exit from the euro area could be managed without harming other countries, a far cry from the alarm of a couple years ago. The leak appeared to be part of a campaign to help Samaras convince Greek voters that the costs of a "Grexit" would be borne by Greece far more than other countries. Not to be cynical, but the worse the Greek economy gets before the election the better for Samaras' chances. A bank run, in which depositors begin taking their money out of Greek banks before January 25 would improve his chances further.

3. Syriza wins and forms new government.

A Syriza victory, with its 50 bonus parliamentary seats, would make Tsipras prime minister as head of a multiparty coalition. Most potential coalition partners would probably be from the left. Radical leftists are unlikely to join, however, because they would benefit from continuing as a protest movement.

Whether Tsipras can negotiate a new troika arrangement that is also acceptable to his own party is highly uncertain. A large part of Syriza is radically anticapitalist and unlikely to change its views once in the government. The euro area/ECB/IMF are unlikely to be flexible toward a government in Athens that has won by denouncing them and unlikely to feel pressure from contagion in Europe from Greece's deteriorating economy.

The euro area can thus afford to wait until the economic situation puts pressure on Syriza, forcing Tsipras to decide whether to risk tipping a new downturn by rejecting a new troika arrangement or a breakup of his government that would come from ditching most of its electoral platform.

Were the 40-year-old Tsipras to navigate this dilemma, emulating former left-wing politicians like President Lula of Brazil, he could dominate Greek politics for a generation and his party would replace the Socialists (PASOK) as the country's main political force in Greece. The lure of putting the discredited corrupt precrisis politics behind him makes it likely that Tsipras would be more pragmatic toward Greece's international partners than he was during the election campaign. A conciliatory approach would also help shield him from Samaras's attacks.

Achieving this new approach would be an almost insurmountable challenge. Syriza lacks a common set of principles and policies. It consists of several political groupings and platforms of varying degrees of radicalism. Tsipras's fraction is merely the largest of these, while others (like the Left Platform) are more radical. They could easily block ratification of a new deal Tsipras might negotiate with the euro area and the IMF.

In the end, it seems improbable that a Syriza-led government could survive long, no matter which choice Tsipras might make. The Greek economy will deteriorate in a matter of months without a new program, probably causing the government's partners (or parts of Syriza itself) to abandon the government and force new elections. An attempt to negotiate a deal would cause the more radical elements of Syriza to desert Tsipras—a most likely prospect because the euro area and IMF are highly unlikely to give a Syriza-led government much leeway. It would be hard for Tsipras to sell a deal that seems to compromise Greece's sovereignty to his more radical supporters. In this scenario, Greece would likely head back to the polls in spring or summer, giving Samaras an opportunity to win.

A Grim Outlook No Matter What

The 2015 baseline outlook for Greece is not favorable. A dramatic new downturn cannot be ruled out. The most dreadful aspect of this situation is that it results from the erroneous assumptions and misperceptions of Greek leaders themselves. Despite what many outside commentators say, Greece is the least likely country to shift from the austerity policies in Europe. It remains a small broke country in need of outside financial aid in a potentially rough neighborhood. In a euro area with no financial contagion, it has zero crisis leverage and will inevitably lose any new game of chicken with its euro area partners and jeopardize its hard won economic stabilization while the euro area's hawks use it as an example of what happens to a country that strays from the traditional policy consensus. In Spain, Prime Minister Mariano Rajoy would not be unhappy to see a Syriza-led government send Greece into a tailspin, vindicating his own tough line against the left-wing Podemos party at home. At the ECB, Draghi would willingly sacrifice liquidity support to Greek banks to illustrate concerns over moral hazard and maybe win Klaas Knot or Jens Weidmann's support for QE in the process.

Outsiders encouraging Greece to defy European austerity and threaten a debt moratorium would, in the words of Pierre Moscovici, the European Commissioner for Economic and Financial Affairs, "be suicidal." The popular idea that such actions would disproportionally damage Germany is also misguided. Yes, Germany would suffer a financial loss, but it could easily afford to do so. Italy and Spain have more exposure to Greek government debt than Germany, so a Greek default would merely drag other vulnerable countries in the euro area down with it, isolating itself in the process.

Whatever happens, Greece will stay in the euro area and explore ways to deal with its huge debt stock, much of which is owned by other euro area governments. Restructuring these loans into 80- to 100-year bonds at concessionary rates or converting them to euro bonds remain feasible options in the longer term—but only if the chronology is right and Greece first completes its economic reform program.


1. €37 billion of this type of assistance was granted to Greece in the immediate aftermath of the 2011–12 debt restructuring. See the Council of the European Union's "Statement by the Heads of State or Government of the Euro Area and EU Institutions" , July 21, 2011.

2. I am indebted to Dimitris Drakopoulos from Nomura in London for alerting me to these significant quantitative limits to short-term Greek T-bill issuance.

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