Greece is running out of money. Greek Prime Minister Alexis Tsipras’s meeting this week with German Chancellor Angela Merkel has taken some of the toxicity out of the conversation for now, but cannot mask Greece’s current collision course with its creditors. Committed to a platform on which it was elected but that it cannot pay for, and with additional EU/ECB financing conditioned on reform, the Greek government is likely to run out of money in April (if not before). If past emerging market crises are any guide, the decisions that it will then confront about who to pay and who not to—the politics of arrears—will present a critical challenge to the government and likely define the future path of the crisis.
Most analysts continue to argue that a deal that allows Greece to muddle through and avoid an exit from the eurozone (“Grexit”) is the most likely outcome. This argument is usually based on the assessment that there is a deal to be had, that Prime Minister Tsipras is a realistic leader that can over time navigate his coalition to a course that balances democratic accountability and a return to growth with the reforms needed to continue to receive assistance, and that both sides have too much to lose from a messy exit.
All this may be true, but the political timeline over which this scenario plays out is measured in months, while the economic timeline is measured in days. The Greek government is now moving to prepare a more detailed set of reforms (including fiscal reform, privatization, social security and labor measures), based on the February 20 Eurogroup agreement, in hope of securing the approval in coming days from eurozone finance ministers. Any agreement reached will require approval by the Greek and foreign parliaments. Interim meetings can at best provide momentum to negotiations that justify short-term financing—most likely in small amounts and conditional on progress—while these negotiations proceed. That means that Greece will soon, perhaps as early as next week, begin to run arrears.
How did we get here? Tax revenue collapsed in the run up to the election, and has contracted further in the uncertainty that has followed. Further, in recent weeks, the parliament has approved a number of anti-poverty measures and a payment plan for tax debtors, generating domestic support but taking policy further away from the previously approved program. It is unclear whether more controversial, but necessary reforms could win approval. As a result, even the reduced government primary surplus of 1.5 percent of GDP looks out of reach on current policies. This is not to criticize the government for seeking to keep its election promises, but rather to stress the large and growing gulf between its plans and what European creditors are willing to support. Unsurprisingly, bank deposits have begun to flow out of the system in the past week (reportedly as much as 350–400 million euros on some days), exacerbating liquidity problems.
By some reports, Greece needs about 2 billion euros to meet its remaining obligations for March and more for April when it faces material debt payments, including to the IMF. Reports are that it will be able to cover the March pension and wage payments from its deposits and it can tap the reserves of pension funds, state bodies and utilities, but the outlook from then onward is unclear. Greek officials are reportedly considering the use of IOUs for the payment of salaries and pensions, and less politically sensitive payments to suppliers are also likely to lag. In his letter to Chancellor Merkel last week, Prime Minister Tsipras signaled that the government might not have sufficient resources for April and would not make debt payments at the expense of social stability.
What comes next? The Greek government would like to tap EU bailout funds, but acknowledges that will take time. In the interim, they are looking for the ECB to provide financing—primarily though the Bank of Greece’s emergency liquidity assistance (ELA) mechanism which now stands around 70 billion—to illiquid Greek banks, which in turn can buy government paper. There should be no mistake that to do so would be pure fiscal financing. Consequently, it is not surprising that the ECB has opposed lifting the 3.5 billion euro cap on the amount of T-bills it will accept as collateral in exchange for central bank loans.
What we have seen in emerging market crises in the past is that the running of arrears puts extraordinary pressure on a government, and this new Greek government is unlikely to be an exception. The decision to pay some and not others involves allocative choices that will be new terrain for the government. Suppliers and other providers of government services are likely to see arrears, differing across different sectors depending on the power of the relevant ministries and the revealed priorities of the government. IOUs might circulate but likely would trade at a deep discount given poor liquidity conditions. Capital controls may be needed to stem flight, putting further strain on the economy. Fissures within the governing coalition could open up. This process is unlikely to be structured and orderly.
In the end, should Greece survive the politics of arrears, they will still need a competitive economy and sustainable fiscal finances, and it is hard to see how the government’s current program gets them there. Sustainability can be achieved through Grexit (and the subsequent devaluation and debt restructuring), or it can be done though a rewriting of contracts to get relative prices right and reduce liabilities (“internal devaluation”) followed by an easing of controls. Either is possible, though the experience of Iceland and Cyprus remind us of the difficulty of getting rid of capital controls once they are in place. Either can produce a sustainable post-crisis Greece. That will be a big decision down the road, but for now Greece’s future is likely to be decided by the decisions made in coming weeks on who gets paid.