06 February 2012 at 15:58 GMT
The Greek government has about 24 hours to decide whether it will agree to the Troika conditions for a bailout deal. Financial markets are hardly showing much concern – but there is a non-trivial chance that Greek does the unthinkable and we must consider the fallout if talks break down.
The weekend and today have seen some progress towards a new EUR 130 billion bailout deal for Greece, but there is much work yet to be done as a deadline looms tomorrow (Greek press sources suggest that mid-day tomorrow is the deadline for signing off on the Troika’s demands. From the Troika’s side, the resolve has hardened as many have complained about the sluggishness of the Greek response to previous demands and Merkel was out just today underlining that “time is running out” for Greece.) The only bargaining chip from the Greek side is the vague hope that they can soften some of the Troika’s demands with the inferred risk of contagion to other European sovereigns and the European banking sysem if Greece elects to take the hard default route.
The Greek government coalition members and Prime Minister Papademos did meet and agree on new budget cuts during the most recent rounds of negotiation this weekend and today, but intense talks are ongoing and we won’t know until tomorrow in this game of chicken between Greek coalition member and PM Papademos and between Greece and the Troika (EU, ECB and IMF) whether this will lead to Greece signing on the dotted line.
The demands from the Troika as a condition for funding the EUR 130 billion (that’s more than 50% of Greece’s annual GDP, by the way) include private sector wage cuts – for example, a 20% reduction in the minimum wage, budget cuts and a 15% cut to supplementary pensions.
The timing of the deal is important now rather than closer to March 20 – when Greece must make a EUR 14.5 billion bond payment – because the between now and then, Greece will have to work through the so-called PSI (private sector involvement) deal that will see a “voluntary” haircut to current Greek debt holders of some 70% according to latest estimates. Some hedge funds are reportedly willing to play tough with Greece on their debt holdings, but a BusinessWeek article suggests that they are underestimating the EU’s willingness to enforce losses. But their efforts could still introduce uncertainty. As well, the Troika will need to transfer the first bailout payment to Greece ahead of that March 20 date once a deal has been agreed.
Measuring the odds
So what are the potential outcomes here? The odds certainly favour a last minute deal in which most or all of Troika demands are met – but the difficulty of the PSI implementation and the potential for further social backlash will remain strong concerns regardless and it is hard to see much upside as ongoing uncertainty will plague Europe and its awkward political/central bank framework.
On the more dramatic side, there is non-trivial threat that one of the Greek government coalition partners fears the popular consequences of bowing to Troika demands and the brinksmanship results in no deal for now. This would result in a hard default and tremendous uncertainty and the strong risk of contagion to the banking sector and other . Is Europe really ready to see the limits of its EFSF (which is a promise – not funds in place!) tested at this time? Doubtful. In any case, the ECB would inevitably ride to the rescue with even further de facto violations of its mandate, but the tremendous liquidity injections needed to keep a lid on things would be rather detrimental to the Euro, which would likely drop quickly to new lows for the cycle against the USD in the event of a hard default.