Greek Crisis Deja Vu

Opinions expressed by Forbes Contributors are their own.

Photo credit to CNBC.com

In the aftermath of the financial crisis in 2009, the so-called “Greek depression” widened Greek government bond spreads and infected global markets in fear of a Greek government default and a Greek exit from the European Union. At 176.9% of GDP, the government debt levels reached astronomic proportions making it virtually impossible for the sunny vacation paradise country to ever repay its obligations, especially in the face of bleak growth prospects.

Trading Economics

Graph credit to Trading Economics

This left two options on the table, debt forgiveness or debt restructuring. It is virtually impossible to convince creditors like the ECB, IMF and Germany, to seriously consider debt forgiveness as that would mean significant asset write off. Thus the only remaining option of debt restructuring has repeatedly led to kicking down the road, the fundamentally undeniable problem that Greece borrowed more than it can ever pay back.  The appealing option of ignoring the root cause of the Greek depression – lack of growth prospect and too much debt burden – has created a Greek-style deja vu every time Greece’s debt obligations became due, in 2009, 2010, 2012, and 2015.
What is different in 2017?

Not much has changed and the same familiar scenario is playing out as in past years with probabilistically limited impact on markets:
The latest report on Greece by the IMF details the Article IV 2^nd review of Greece’s third bailout program from 2015. With large debt redemptions due in mid-July, the IMF has challenged the viability of the current program because of the inability of Greece to achieve their tight fiscal targets and a lack of trust in Greece’s long term debt sustainability. The current government’s slow progress on economic reforms and a lack of any real growth in the economy has led to another cycle of economic stagnation and a lack of confidence in the current SYRIZA government led by Alexis Tsipras. The ability to come to an agreement with both the European creditors, ECB and potentially the IMF on a new debt program will require difficult compromises but would likely lead to another restructuring.

Bloomberg

credit to Bloomberg

The familiar movie is playing again. The IMF will be pushing for a firmer commitment for debt relief from Greece’s European creditors which would result in lower interest rate payments and extending the maturity of the current debt profile and possibly longer term debt forgiveness. Germany will push back strongly on any haircuts on Greek debt. The elections across Europe will cause both sides to agree to a “Lend and Extend’ strategy but the IMF’s view on longer term sustainability could set the path for a compromise and a stronger realization that Greece is in an economic worm hole with no strategy for emerging on the other side with any success.
There are some notable differences from 2015, that may lead to a different outcome increasing the tail risk of a Greek default and a potential Greek exit:
The resurgence of nationalism and separatism has spread across Europe post Brexit.  While leaving the EU was considered anathema in past years, now Greek citizens know that leaving Europe is not only possible but may be even preferable.  Similarly, pre-election sentiment in other European countries such as France and Germany herald a distinctly “my country first” philosophy reminiscent of post-Trump America. The wind change in Europe, this time is drifting each country apart from the rest.
On the other hand, the Greek creditors realize the dangers of the change in sentiment and are likely to tread lightly:
For example, the IMF released a recent blog titled “Dealing with Sovereign Debt – The IMF Perspective.” This blog set out an internal strategy that creates a plan for allowing the fund to come to the Executive Board with a new financial program for Greece that would allow for the IMF, The EU (specifically Germany) and Greece to find a sustainable path that would satisfy the ESM disbursements needed to make necessary payments in July to the ECB and private market bondholders. This plan will be both realistic but also delicate enough to allow for the SYRIZA government and the EU to feel like they have won.
The IMF blog laid out a path for debt relief that can be made conditional on the full implementation of the program for Greece. The idea would be to push off any needed relief to 2018 but would be agreed upon at the beginning of the new program. The IMF wants to create a framework for success that is both credible and realistic given the modalities of the current debt structure. The IMF has guided the market that member countries should restructure unsustainable debt without a disruptive default. The IMF’s blog described a way for Europe to embrace the realities of Greece’s current and future financial situation. The roadblock lies in Germany, where recent statements by the German Finance Ministry’s Wolfgang Schauble stated that Greece would not be given a “haircut” or debt forgiveness and that the ramifications for the likes of Spain, Portugal and possibly Italy are too great to allow for such a precedent to occur. 
·    Under the agreement from third Greek bailout, the IMF would only be involved as a creditor if its DSA (Debt Sustainability Analysis) led the IMF to believe that the current outlook for Greece was one where Greece could meet its future fiscal targets. The original inclusion of the IMF was for political reasons given the fund’s expertise in creating, monitoring and helping to enforce the conditions of the previous program.  The IMF challenges the efficacy of the 3.5% of GDP primary surplus target and suggested a 1.5% target mixed with a formula for substantial debt relief. The fund has called for broadening the tax base to try and include more of the middle class and further ways to get budgetary savings from reducing the costs of the pension system on the government balance sheet.
·    The IMF and the EU differ mostly on Greece based on the projections of primary surplus sustainability. To reach the needed surplus, the Greek government will need to agree to many reforms during a period where European politics are fragile and Prime Minister Alexis Tsipras’s popularity is gradually falling. Growth is the main problem that has led to a lack of faith in debt sustainability.

Bloomberg

·    The IMF is likely to compromise on its position, ever so slightly, with the idea that it has made its point that the long-term sustainability of Greece is in serious jeopardy and a more radical approach to solving the Greek economic problem is needed in the future if reforms are not implemented. The European Union is likely to bend ever so slightly because it needs the IMF for credibility. The market would look down on an “ESM/ECB” only program. The market would question the lack of conditionality of the program itself and that an ESM only program would require parliamentary approval in Germany, Netherlands, and Finland. Such an outcome would be highly disruptive to the German elections in September and would most cause an increase in European sovereign and corporate bond yields, a pressure on European equities (Bank stocks) and a flight to German bunds.

Bloomberg

Data Source: Bloomberg

A Likely Compromise:
The most likely outcome would be for the IMF / EU to work with the Greek government to legislate now for a deliverable reform implementation of 2018 and 2019. This would require a bridge financing relationship before July with the hopes that a new program will result in Greek bonds being included in the European Central Bank’s quantitative easing program. The current Greek government will need to agree to certain labor, energy and pension reforms that will be pushed off for the next government to implement. The positive side of this agreement is that the current economic situation may seem dire but there is possible political relief towards the end of 2017 in Europe. The Greek opposition leader Kyriakos Mitsotakis from New Democracy is considered one of the most reformist and thoughtful economic minds in all of Europe. Mitsotakis has asked Angela Merkel and Wolfgang Schaeuble directly for what he calls “Fiscal Air” to provide some short-term relief to a difficult economic situation at home in Greece. Mitsotakis stated after his meeting “The sacrifices of Greek people should not go to waste. After seven difficult years, Greece should finally emerge from the crisis and not get into a new vortex. In this effort, we will need the support of our partners. A support, which will not only benefit Greece, but will also contribute to strengthening European cohesion at a difficult time for the European Union.”

• Greece’s current Prime Minister recently proclaimed to parliament that the “Era of Austerity” is over and he has negotiated an end to the age budget austerity. Tsipras stated “I am fully convinced we achieved an honorable compromise with Brussels after 7 years to leave the path of continued austerity behind us.” In exchange for legislating new reforms in 2019 (which will be fiscally neutral), Greece’s creditors will return to Athens to complete a review of the current debt program.
• In the short-term we should look for a hard line from the Germans and tough rhetoric from the IMF but we expect a compromise to be made amongst the Troika that allows for a temporary solution until French and German elections are concluded. A longer-term debt deal will depend on German politics (Merkel-Schulz coalition) and possibly a new government in Greece led by the “Pro Euro” New Democracy leader Kyriakos Mitsotakis. We are cautious Greek assets in the short term but are more constructive over the medium and long term given the recent developments internally and with its global creditors.

Important Dates:
Eurozone Finance Minister Meetings - March 20^th, April 7^th, May 22^nd, June 15^th
Dutch Elections - March 15^th
French Presidential Elections – April 23^rd, May 7^th
French Parliamentary Elections – June 11^th, June 18^th
German Elections – September 24^th
Euro 2.1B GGB 2017 payment – July 17^th
Euro 300M IMF repayment – July 18^th
Euro 3.9B ECB repayment – July 20^th

Katina Stefanova ,  

Contributor