Mixture of Hope and Fear for Eurozone After Greek Elections

The anti-bailout leftist Syriza party achieved a stronger-than-expected victory with 36.3% of the vote at yesterday’s Greek general parliamentary elections, Greece’s Interior Ministry reported this morning. This translates into 149 seats, just short of the 151 needed for a majority. Party leader, Alexis Tsipras, met anti-bailout right-wing party Independent Greeks (ANEL) this morning where they agreed to form a coalition government.

A core premise of the two parties is that the bailout programme negotiated between the troika and the previous ruling coalition has failed to address core structural issues such as tax evasion and social justice and has made short-term performance -especially in employment and earnings – worse. In response, they advocate a departure from the mantra of austerity, which they propose to support through fiscal stimulus made possible through debt reduction.

In theory this is what many economists – including Cebr – are arguing for and even the IMF itself has admitted to too much austerity as a mistake on their part. In practice, the fear is that the Syriza is unprepared for the storm awaiting it. While there seems to be consensus between Syriza and Eurozone officials that Grexit should be avoided, there are important differences between the economic programmes of Syriza and the Troika. The last review of the Troika is still pending and the Eurogroup has extended the deadline to end-February. After that, the funding of Greek banks becomes a challenge given that the ECB has indicated that it could no longer accept Greek government bonds as collateral if there is no agreement.

The IMF programme runs until Q1 2016. Greece’s new government therefore will either have to finish the review and move on to the Enhanced Conditions Credit Line (ECCL) discussions as suggested in the last Eurogroup, or make a radical move and open up new negotiations. The second scenario is more likely in our view. The fact that Syriza has been able to find Coalition partners so quickly reduces the period of political uncertainty post-election that we had identified in an earlier note as a clear risk. It also maximises the time available for negotiations. The talks are expected to be structured around three key themes: The first is debt relief. The immediate reactions from Europe’s creditor countries – most notably Germany – have sent strong signals against the possibility for outright haircuts. Given this, Cebr thinks it more likely that a compromise on debt relief – if at all achieved – will take the form of extending maturities and lowering costs. The second theme relates to structural reforms: Syriza’s pre-election campaign involved promises to reverse some of these measures, but the Troika sees such reforms as a crucial precondition for growth. Finally, the question of easing austerity will also be on the table: our base case scenario is that the primary surplus targets will be eased somewhat from the current target which is set at 4.5% of GDP until 2022.

The outcome of these talks will be crucial for Greece’s future and the future of the Eurozone. There are many who continue to believe that a Syriza-led government will make extremist demands to Greece’s creditors to the extent that these are not met and that Greece has to leave the Euro. We disagree. We continue to believe that there is plenty of room to reach an agreement and that the scenario of a Greek exit from the Eurozone carries a low probability. There are a number of arguments in support of this view. First and foremost, Syriza ran on a campaign that promised Greeks to stay in the euro and does not have the democratic mandate to force negotiations to an extreme. A recent opinion poll indicated that 76% of Greeks want to stay in the euro “at all costs” and Syriza is well aware of this. In fact, the party has moved far from its earlier radical positions and if history is a good guide we expect it to become even more pragmatist once it assumes power. What is more, we think that Greece’s primary surplus is not as strong a bargaining chip for Syriza so as to back up tough talks with the troika.

The argument runs that with a primary surplus (a positive difference between revenues and spending once the cost of servicing debt is excluded), Greece can threaten its creditors to default on debt since through enjoying higher tax revenues than are needed for its spending an economy does not need to borrow more. This is a fantasy. If cut from the Troika, the bank runs and elevated uncertainty that will result will make the primary surplus disappear through a contraction in credit and output. The creditors from their side are also in a weak bargaining position and will be working towards a compromise. While in the period between 2011 and now significant reforms have taken place in the Eurozone to lower contagion in the event of a Grexit, the risks are still very high. Crucially, Greece’s exit from the euro would be a game-changing event for the character of the currency bloc, transforming it from what was conceived to be a permanent monetary union into one where exit is a possibility. Even if Greece exits therefore, this would have serious repercussions on what happens to the rest of the periphery once they start to run into similar troubles.

In summary, whilst we acknowledge that Syriza’s victory creates significant risks for Greece and the Eurozone as a whole, our central scenario is that the two sides (Greek government and the Troika) are more likely than not to reach a compromise. Ultimately, this will be a good thing for both Greece and the rest of the periphery. As Cebr has repeatedly argued, monetary expansion is insufficient to cure the problems of weak demand that the Eurozone currently suffers from. Setting the fiscal motors to work in the same direction is imperative. The new Greek government will have to convince its creditors that it can walk the delicate tight-rope of relaxing austerity without back-pedalling on structural reforms.