Courtesy of James Shugg and Sean Callow at Westpac Global Economics:
The Eurogroup of finance ministers and central bankers met in Riga last Friday amidst (accurate) speculation that little progress would be made towards reaching an agreement between the Greek government and its creditors on the measures Greece must (re)commit to in order that the long-delayed bailout tranche of EUR7.2bn be released – enabling Greece to meet upcoming debt repayments and other commitments.
Riga, of course, is the capital of Latvia, whose 2008 credit and budget crisis resulted in an IMF bailout conditional on harsh austerity measures that reined in the budget deficit. But the consequent cuts to spending, wages, pensions and services, plus tax hikes required as part of that bailout saw the economy shrink a staggering 18% in 2009. The social cost was devastatingly high, with traditional industries wiped out, unemployment quadrupling to over 20%, and the emigration of 10% of the labour force – mostly the younger generation.
Through it all, the Latvian Lat peg to the euro was maintained – an easy fix via devaluing the currency to boost competitiveness was eschewed. Despite widespread community resentment and bitter recriminations, political fallout was not enough to derail the austerity/bailout program, and in 2011, Latvia regained access to financial markets. In 2014, with an economy smaller than in 2008 but growing again, Latvia joined the euro – “proof” to some that austerity works and brings its own rewards.
The no doubt coincidental location of the April 24 Greece meeting may have taunted some participants and given encouragement to others, but no complex financial crisis is ever the same. The first Greek bailout in May 2010 came 18 months after Latvia’s; and 18 months thereafter, in late 2011, as Latvia exited its bailout, popular kickback against the clumsy brutality of the Greek bailout and the contagion it fuelled threatened the breakdown of the Eurozone itself – by then on the verge of entering a drawn out recession.
Compromise, debt restructuring, political change, audacious policy-making and the return of risk appetite over the next three years saw the Eurozone crisis subside and economic growth return, even in Greece. But after five years of recession, the Greek people in January voted in a new government with a mandate to stay in the Euro under renegotiated, less-austere conditions.
The Syriza-led coalition, governing Greece for the first time, appears to have a mandate that is undeliverable. It has drawn on its historical ties with Greece’s socialist past to nurture links with Russia and argue for the Ukraine sanctions to be eased, throwing a spanner in the works of European foreign policy unity in one of several clumsy attempts at finding a bargaining chip for the bailout talks. After much bad blood in negotiations, agreement was reached on 20 Feb to extend the bailout program by 4 months rather than the 6 months requested by Greece. It was conditional on Greece delivering a list of promised reforms for the next 4 years, such as boosting tax receipts and cuts to government payments, including pensions and privatization.
No bailout disbursements have yet been made because no comprehensive and detailed list of measures has yet been provided by the new administration that is acceptable to the creditors who are not prepared to wear any further haircut. The deadline for Greece to submit its reform plans has been moved back several times and now seems to be June 30, when the bailout is due to be indefinitely suspended – whether funds have been disbursed to Greece or not.
Although Greece raised limited funds in the short-term market in early April and made a closely watched EUR450mn payment on 9 April, its fiscal position is fragile. The government has taken steps to draw on funds held by public entities such as local councils and public pension funds in addition to rolling over short-dated debt, which is bought by Greek banks using funding from the Bank of Greece (BoG). The BoG in turn is drawing on the ECB’s Emergency Liquidity Assistance program (ELA), through which it lends to Eurozone member central banks so long as it regards the emergency request as being due to temporary liquidity constraints – not solvency.
Greek banks are under ongoing pressure from deposit withdrawal. At the 15 April press conference, ECB President Draghi said ECB exposure to Greece was EUR110bn; last week the ECB was reportedly considering pulling the plug on this support for the Greek banks, but it remains in place for now.
What’s next?
Westpac’s base case is that both sides of the table, the troika lenders and Greek government, are sufficiently averse to a Greek default and/or exit from the Eurozone that they will eventually reach agreement. (This includes the ECB officials insisting that EMU exit is not an option).
Both sides should be able to present a deal as a victory: Greece would receive the delayed funds, while the lenders could cite a list of tough-looking fiscal reform promises by Greece. Most of the movement would probably have to come on the Greek side: it should finally commit to stronger reforms as the least-worst of a range of unattractive options, including yet more elections or leaving the Eurozone (which opinion polls in Greece continue to reject). The catch hidden in this scenario is that no further creditor participation (i.e. debt write-downs) condemns Greece and its creditors to further iterations of current events, with the country’s debt burden (including the bailout loans) simply unsustainable into the medium term. A deal by June 30 just starts the clock ticking ahead of the next bailout showdown.
If a deal is not reached, or seems impossible, speculation that the ECB will withdraw the emergency bank funding would trigger a renewed run on Greek bank deposits, quite possibly even ahead of any default by the government. The government would impose capital controls, effectively suspending the fiat characteristics of the euro – the first step towards abandoning the currency. Financial and economic chaos in Greece would ensue, albeit with limited contagion elsewhere in the Eurozone.
Whether or not Greece leaves the Eurozone soon after would depend on a range of political decisions across the region, but policymakers have made it fairly clear that, whatever the official rhetoric, preparations and planning are underway to deal with the quite significant risk that the irrevocability of the euro is soon tested. It could be argued that such a tumultuous event could, over time, engender a more favourable set of economic outcomes for both Greece and the broader Eurozone.
EUR/USD rallied on the Feb deal and should find some support on an agreement to release funds to Greece, whether that is in May or June. But the overarching driver of EUR/USD should be relative monetary policy, which points the pair lower multi-month – our year-end target is 1.02.
Key dates
End-April Greek government to pay EUR1.7bn public sector wages and pensions
11 May Eurogroup meeting
12 May Greece owes EUR763mn to IMF
5 June Greece owes EUR312mn to IMF
12 June Greece owes EUR351mn to IMF
16 Jun Greece owes EUR576mn to IMF
18 June Eurogroup meeting
30 June End of 4 month conditional extension to bailout program
