Article / 28 April 2015 at 15:29 GMT

It's decision time on Greece

Blogger / MoreLiver's Daily
  • Greece's debt likely unsustainable
  • Default and 'Grexit' not one and the same
  • Syriza serving as a scapegoat
By Juhani Huopainen

The real questions about Greece

Eurogroup meetings that have gone nowhere, looming payment deadlines and the brinkmanship of both Greece and its creditors have led to much publicity about the imminent threat of a Greek default and possibly an exit from the Eurozone.

The first question should be whether Greece’s debt is sustainable, and also if the current plan is realistic. Secondly, Greece’s possible exit from the monetary union and default are two separate issues. Thirdly, Greece’s debt should not be viewed as a lump sum, instead the country’s creditors should be examined separately.

Is Greece’s debt sustainable?

I believe it is safe to say that Greece’s debt is unsustainable. While many have pointed out that Greece’s debt service payments are relatively low (as a large part of the debt has very low or zero interest rate payments), this misses the big picture of what would be needed to return the debt level to a sustainable point. 

It is easy to lose sight of the big picture. Photo: iStock

The current road map for Greece requires a primary budget surplus of 4.5% of gross domestic production for the whole programme. The International Monetary Fund estimates that the true required number is closer to 7.5%.

As Bloomberg’s article from last February points out, running a 4.5% surplus is very rare. Usually only countries like Switzerland or oil producers are able to pull off anything like that. For other countries, such levels can usually be reached only for a limited period of time. 

(Examples? Ireland just before the financial crisis pricked the real estate bubble and Finland around the Nokia heydays come close...)

It is safe to say that Greece is neither Switzerland nor a Nokia-boosted Finland in the midst of a credit boom. There is no way how Greece could be like that, especially given its weak economic base and lack of policy options to spur growth.

Grexit and default are not the same thing

Greece’s exit (either by its own choice or by being forced out) and Greece’s default are often carelessly linked. While a default within a monetary union should – and could – be plausible, there is a very good reason why the exit and the default are often coupled.

The reason is that the leaders of the euro area’s institutional leaders (ECB, EU) are worried that a Greek default could lead to speculation that other over-indebted countries (Portugal, Ireland, Spain, Italy) could also default at some point, which would destabilise their bond markets and banking systems.

This is an intentional misunderstanding. Greece’s unsustainable debt does not make Spain’s debt unsustainable. Spain’s debt either is, or is not, sustainable, regardless of Greece’s situation. The institutional leaders are actually scared of the euro area’s political leaders.

The political leaders, who have mutualised large parts of debt that should be considered unsustainable, are afraid of admitting the looming losses to their voters. This explains why Greece is ferociously painted as an isolated case – and the ECB’s sovereign bond purchase programme helps in this by supporting the bond markets of the rest of the crisis countries. 

I bet the political leaders knew right from 2010 that Greece would eventually have to default. After the mutualisation of the Greek debt, the political leaders now need a scapegoat. Greece’s socialist government is perfect for this.

How do Greece’s creditors differ?

Greece’s creditors include a limited number of private sector holders, other euro area countries via bilateral loans, European rescue funds, the European Central Bank (ECB), and the International Monetary Fund (IMF).

Open Europe's Raoul Ruparel writes that if an IMF payment is missed, it would not cause anything beyond a notice of a late payment (for the first 30 days). After one month, the IMF’s managing director would then have to notify the IMF board.

At that point the European Financial Stability Facility and the bilateral loans given to Greece by other euro area countries directly could have to be reviewed – being overdue in payments to the IMF could be constituted as a partial default, but the rules of the EFSF and bilateral loans do not force this. Rather, it remains an option.

Martin Sandbu of the Financial Times adds that, of the remaining EUR 20 billion left in the third bailout programme, most comes from the IMF. Sandbu believes that the IMF could theoretically go ahead and send the remainder of the bailout money to Greece. These funds would allow Greece to make its payments to the IMF.

The Treasury bill maturities are large but at least until now, Greek financial institutions have been rolling them over. It could be assumed that the banks would continue doing so for the time being.

The bonds held by the European Central Bank are the last remaining problem. The FT’s Sandbu also suggests that the ECB could do a debt swap, effectively rolling over the maturing bonds to longer maturities. It does sound a bit like monetary financing, but what doesn’t?

Key payments

May 1    200 million to IMF (interest)
May 8    1,400 million T-bills due
May 11   Eurogroup meeting
May 12   774 million due to the IMF
May 15   1,400 million T-bills due

June 5     305 million to IMF
June 12   343 million to IMF
June 12   3,600 million T-bills due
June 16   572 million to IMF
June 19   343 million to IMF
June 19   85 million interest to ECB
June 19   1,600 million T-bills due

July 10   2,000 million T-bills due
July 13   500 million to IMF
July 14   90 million bond maturity
July 19   225 million bond interest
July 20   381 million bond interest
July 20   3,500 million to ECB

What way forward?

Every time Greece demands haircuts or implicitly threatens its creditors with a default, depositors in Greece move their money out of the country as they fear Greece’s exit would lower the value of their bank deposits. This keeps the Greek banks dependent on the Emergency Liquidity Assistance provided by the ECB, which is the only real chokehold of the creditor countries on Greece. 

If Greece does not agree to creditor countries’ demands to extend-and-pretend, the Greek banking system will be wiped out.

The real question is should the eventual losses to the creditors be recognized now, or should the can be kicked down the road? Greece needs another bailout this summer. Depending on the political moods of its creditors, if the bailout is denied and the losses are recognized it might make political sense to make it look like Greece is non-cooperative and not worthy of a new bailout. 

On the other hand, if a new bailout will be made, the creditors could lose less political will by making it look that they have played hardball during the negotiations.

Key dates to watch

The next big date will be the Eurogroup meeting on May 12. The hard deadline is July 20, as on that date the EUR 3.5 billion in bonds held by the ECB mature. Greece will not be able to make that payment without a bailout extension. 

The weekly non-monetary policy meetings of the ECB, which agree on the ELA amount to the Greek banks, is the only thing keeping Greece afloat and away from a default and capital controls.

Contagion effects small, but exits

The Greek bond yield started rising toward the end of 2014. The looming election win of the Syriza party, the previous government’s failure to secure the final tranches of the Greece’s second bailout and the lack of existing third bailout suggested that brinkmanship and crisis was ahead.

But the ECB’s purchase programme kept the bond yields of all other countries – except Greece – trending lower. Only during the first half of April did the yields in Spain, Portugal, and Italy rise moderately while yields in Germany, Finland and other countries continued lower.
Euro yields Create your own charts with Saxo Trader click here to learn more.

Back to politics in PIIGS

It seems contagion is very limited. The key question is how Greece is handled....

If Greece is seen to reach some of its goals, for example lower primary surplus requirement or restructuring, other crisis countries might think a fight with the creditor countries is worth it. That would require political will. It looks like the more radical, "eurosceptic" parties have weakened considerably during the past couple of months.

The BBC’s Duncan Weldon wondered if we have passed “peak populism”. I answered that the political shift has only begun. It’s the harsh competition for the dissenting votes that makes dissent look passé – but it's not. It just makes it harder to form strong governments and the established parties are too scared to act decisively to end the crisis, either with debt restructurings and breaking up the euro, or alternatively with a transfer union.

If Podemos in Spain is losing votes to another new (but moderate) party, this does not present change. I believe Paul Krugman was right: change will not happen until we get a political victory where the winner doesn't care about its later reputation.

The muddle-through scenario is here to stay – until it isn’t. When governments do not act, others have to. When nobody has power, or when there are few rules, the one who seizes it "by accident", rules. 

Now this is the ECB. Let’s hope it knows what is best for us.

ECB headquarters in Frankfurt

Will ECB officials make the right choice for Greece and for Europe? Photo: iStock

— Edited by Michael McKenna

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.


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