The final outcome of the Greek debt crisis has been obvious from the beginning. The Hellenic nation will need to restructure its debt, writing off a substantial portion of what it owes. It may need to leave the Euro, allowing the country to devalue to regain competitiveness relative to its peers like Turkey.
Since the February 2015 ‘deal’, the parties had inched close to a new agreement about the previous agreement in a prolonged battle of alternative drafts. On Saturday 27 June 2015, Greece’s Syriza led government refused to commit to the latest terms presented by creditors, choosing instead to call a referendum on the subject scheduled for 5 July.
The referendum was a cynical exercise in political expediency rather than democracy. If this step was deemed necessary it could have been called months ago when the creditors’ position had become very clear.
While the referendum required Greeks to simply vote yes or no, the lengthy question was less clear: “Should the draft agreement submitted by the EC, ECB, IMF to the eurogroup on June 25, which consists of two parts that make up their full proposal, be accepted? The first document is titled ‘Reforms for the completion of the current programme and beyond’ and the second, ‘Preliminary debt sustainability analysis’.” It was not clear whether the Greeks were being asked to vote on the agreement, membership of the single currency, participation in the European Union itself — or all of these things?
The first question in the Referendum was largely irrelevant as it was on a plan that had already lapsed. The EU had withdrawn its 25 June offer. With the expiry of existing deals on 30 June, there was no deal to extend.
The second question on the International Monetary Fund (“IMF”) Debt Sustainability Analysis was on projections of the ability of Greece to service its debt under different scenarios. It is certainly the first time, as one Greek observer noted, that a national referendum has been conducted about a spreadsheet!
In parallel to the referendum, the Greek government opened a number of legal fronts in the economic war. It sought to access funding from the European bailout funds, invoking specific provisions. It considered an approach to the European Courts to prevent Greece being ejected from the Euro.
An immediate result of the announced referendum was the withdrawal of essential support from the European Central Bank (“ECB”) for the Greek banking system. This triggered an indefinite banking holiday as well as restrictions on withdrawals and transfer of funds overseas.
The Greek Referendum was always going to be a Rorschach inkblot test, with everybody projecting their own perceptions onto the result. The Referendum may be ‘a triumph for democracy/a cynical political farce’, ‘good/bad for the single currency and the European project’ etc. [select as required].
Voter turnout was around 62 percent. The result was not a considered deliberation of the issues by a well informed electorate exercising their democratic rights. It was influenced by the general confusion deliberately fomented by politicians. The No Vote ultimately reflected a reaction against European arrogance, illustrated by heavy handed threats by several politicians and functionaries.
It is not clear what the No vote signifies, especially as both the Greek people and their government want to remain within the Euro. The Syriza government believes that it gives them a popular mandate to negotiate a new agreement which will provide a new €29 billion two-year bailout, on terms which are less onerous and more favourable to Greece. European creditors, who considered the result “regrettable”, claimed that No was a vote for the Hellenic nation to leave the Euro.
Both sides are trying to put a positive spin on events. But if this is a win for anybody then it is reminiscent of French philosopher Jean Paul Sartre’s observation: “Once you hear the details of victory, it is hard to distinguish it from a defeat.”
The reality is little has changed and the troubles of the Greek people are likely to intensify not abate, as the nation will now have to confront several issues.
One issue is the weak Greek banking system. Banks deposits have fallen by almost half as capital flees Greece.
The funding problem is compounded by other problems. Bad debts are rising as the economy contracts and borrowers default strategically to obtain write downs of their debt. The banks are large holders of Greek government bonds which would result in large losses if there was a default. Greek bank capital is of poor quality, with a high proportion consisting of deferred tax assets in the form of future tax credits from the government.
The immediate priority is the reopening the closed banking system, which remains, as it has since late 2014, dependent upon funding from the European Central Bank (“ECB”). Without an increase in Emergency Liquidity Assistance (“ELA”) currently frozen at €89 billion, the Greek banks cannot operate and are likely to run out of cash shortly. An additional complication is that Greece must make €3.5 billion payment on a bond held by the ECB on 20 July.
The ELA rules are helpfully vague, providing considerable scope for action. National central banks can extend ELA funding unless “the Governing Council of the ECB [with a majority of two-thirds of the votes cast] considers that these operations interfere with the objectives and tasks of the Eurosystem”.
If Greece defaults on its payments, then it would become difficult for the ECB to continue assistance. The ECB has the option of maintaining its current freeze. It has also tightened collateral requirements which reduces the funding available to the Greek banking system.
If the entire ELA was called in by the ECB, then the Greek banking system would collapse. This might trigger losses for depositors as Greece’s deposit insurance scheme is underfunded. Greece’s persistent desire to remain in the Euro means that it does not have the capacity to create currency to recapitalise its banking system.
New Deal for Greece
A new agreement appears unlikely to be on more favourable terms than that on offer prior to the Referendum. If based on the proposed agreement, as is likely, then it does not address the real issues.
The terms of the 25 June 2015 represented a few concessions by the creditors but required almost total capitulation by the Greek government. The Greek Prime Minister had conceded on most of the creditor’s demands and reports suggest that prior to the breaking off negotiations the difference between the parties was a modest €60 million.
The agreement would have committed Greece to a primary surplus (budget position before interest payments) of 1 per cent in 2015, rising to 3.5 percent by 2018. There is disagreement about the mixture of spending cuts and tax increases to achieve these targets. The Greeks favour tax increases. The creditors, especially the IMF, want cuts in spending. They consider business tax rates to be already too high and spending in areas like pensions to be unsustainable.
The proposed agreement was only for 5 month extension, necessitating a more comprehensive further program. Any new agreement will be of longer duration, probably requiring creditors to provide new financing to Greece (in effect a third bailout) if default is to be deferred.
The focus was originally on the release of €7.2 billion from the existing program, later increased to around €17 billion. If the amounts that Greece has run down from reserves, pensions and also its account at the IMF were replaced, then there was little new funding to Greece.
Greece has commitments of around €5-10 billion each year plus the continuing need to roll over around €15 billion in short term Treasury bills. Greece may not have the ability to meet these obligations on an ongoing basis. This does not take into account additional funding needs of the State that may arise from budget shortfalls or the need of Greek banks. According to the IMF, Greece may need a further €50-60 billion, including around €30-40 billion in new financing, simply to make it through to end 2018. This amount may significantly underestimate the funds required.
Debt repayments or relief were not addressed in the 25 June agreement, other than in vague terms. Greek demands for debt relief at the same time as they request further funding may not be favourably received by many creditors.
As the scheduled €1.5 billion payment due was missed, the IMF has made it clear that it cannot provide funding to Greece until the arrears are remedied. Germany has made it clear that IMF participation is required for its support for a new agreement.
Even if an agreement is reached then it is unlikely that it will result in a significant alleviation of the austerity programs and hardships of ordinary Greeks. More importantly, the chances are the parties would be back at the negotiating table in the near future as the agreement unravelled.
The ability to meet plan commitments is affected by the state of the Greek economy.
The lengthy negotiations, political uncertainty, capital flight and the recently imposed banking restrictions and capital controls have crippled the economy. The Greek economy, which is around 25 percent smaller than in 2007, is probably in recession and continuing to contract.
Bankruptcies have increased. Tax receipts have fallen, making budgetary targets difficult to meet. Delayed payments to suppliers and citizens cannot be continued indefinitely as a means to improving public finances
Recent events may affect tourist traffic over the critical summer period, which may fall by up to 40 percent as holidaymakers switch to Turkey, Spain or Portugal. Critical shortages due to capital controls have exacerbated pre-existing problems, reducing activity with further layoffs and closures.
If growth falls further with the continuation of austerity, then the primary surplus objective will be missed creating additional funding needs.
The continued obsessive emphasis on budgets ignores the need for major structural reforms. Continuing membership of the Euro restricts the ability of Greece to devalue to improve competitiveness. Further internal devaluation (lowering of costs) and structural changes, the only options, are difficult as well a punitive.
Many of the proposals under consideration are old. Promised proceeds from privatisations, reduced over time, have proved elusive. Proposals for higher taxes and pension contributions from companies require improved tax collection and reversal of tax amnesties. Successive Greek governments have proved poor at implementation. It is not clear why this time it will be different.
Political uncertainty remains. Greek Prime Minister Alexis Tsipras is vulnerable. The referendum was politically motivated, invoked to protect the position of the increasingly beleaguered Prime Minister under attack from certain elements of his own party and coalition who rejected austerity. Some commentators have even suggested that it was designed so that a Yes vote prevailed allowing the Syriza government a graceful exit avoiding the opprobrium of having to commit Greeks to further austerity.
It has exposed deep schisms within Greek society. A divided population has consistently chosen the contradictory position of rejecting austerity and repayment of odious debt while wanting to remain part of the euro. This is based along socio-economic lines. The more affluent prefer to stay in the Euro and to enjoy European rights. The disadvantaged, including the old and the young, who have borne the bulk of the cost of austerity are more open to leaving the single currency which has not benefitted them to the same extent.
Relationships between Greece and the rest of the Eurozone are now poisonous.
The creditors and taxpayers in Eurozone member countries now face large losses on their commitments. Politicians who have repeatedly assured their citizens that the bailout commitments will not result in losses are now compromised. Italy and France as well as the troubled nations of Spain, Portugal and Ireland, may find their fragile public finances exposed by the losses.
There is little sympathy for Greece, outside of perhaps France and the European Union (“EU”). The French government is concerned about the effect of a Greek exit from the Euro on the political threat posed by the National Front. The EU cannot risk the damage to its power and prestige from a Grexit.
Countries like Italy and Slovakia have made it clear that they cannot support pension arrangements sought by Greece which are better than that available to their own citizens. Domestic considerations in countries like Germany make it increasingly difficult to support a new agreement and the inevitable provision of further funding.
There are strategic considerations. Stronger countries will need to decide how much more political will and money will be extended in support of weaker members. This will shape Germany and Northern European positions on further support for the peripheral countries if support is needed in case of a Grexit. If these countries want to limit their large exposures then the viability of the European project weakens.
The creditors also are mindful of how events in Greece may affect elections due later in 2015 in Portugal and Spain. Concessions to the Athens may encourage a further shift to anti-austerity parties, such as Spain’s Podemos, and replay of the Greek crisis.
Old Europe Old Ways
For six years, no European leader or institution has been willing to take responsibility for or have their fingerprints on the instrument that triggers the sequence of events that brings about the inevitable conclusion. A Greek default and departure from the single currency would tarnish the legacy of many policy makers and politicians, such as German Chancellor Angela Merkel.
Europe’s handling of the Greek crisis has revealed its inability to face up to inconsistency between a single currency, one monetary policy, national fiscal policies, national banking systems and lack of political integration. It has also exposed a ponderous decision making process. London’s Daily Telegraph pithily summed up the problem with five identical images dated 2011, 2012, 2013, 2014 and 2015. In each, a stern German Chancellor Merkel tells various Greek Prime Minsters: “This is your last chance.” In the foreground, flowers wilt with the passage of time.
The creditors have set Sunday 12 July as the new ‘final’ deadline for proposals from Greece for a new agreement. But given past history, nothing is likely to happen quickly. At best if Greece does not capitulate or no progress is made, then the ECB may reduce or withdraw support. This may necessitate Greece issuing a parallel currency or IOUs as a temporary measure, perhaps ultimately forming the basis of its new currency.
But given the sheer logistical impossibility of reintroducing the Drachma quickly and unravelling the complex inter-relationships between Greece and the EU, it will be a drawn out and painful affair. The Greek government has stockpiled oil and food for an expected siege. It might get one as the creditors and the ECB apply relentless pressure to strangle the Greek economy looking to force concessions.
Greece is a crucible for the future of other heavily indebted nations in Europe and elsewhere; a portent of the economic, social and political reckoning that will be difficult to avoid. Whatever may happen it will destroy the lives, hopes and futures of many Europeans, in Greece and elsewhere.
© 2015 Satyajit Das
Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money