Syriza’s victory in Greek elections yesterday, and the announcement this morning that they would rule in coalition with the right-wing Independent Greeks party, all but ensures a confrontation between Greece and its European creditors over austerity and debt. While Greek markets have continued their sell-off on the result, 10-year yields near 8.9 percent are still down from earlier this month and well below earlier crisis levels. In line with these numbers, most market analysts believe a deal is likely that would avoid a Greek exit from the eurozone, noting some moderation of Syriza’s rhetoric in recent days and upcoming meetings with creditors. But what would such a deal look like? Greece and its creditors are so far apart, their perceptions of their negotiating leverage so different, and time so short to reach an agreement, that the risk of failure seems higher than implied by market prices. A few points.
First, Syriza has promised a substantial fiscal expansion, a greater role for the state, and demanded relief from its unsustainably high debt (most of which is now owed to the public sector). I am quite sympathetic to the need for less fiscal austerity and debt relief for the periphery. And there are some interesting proposals for how that could work. But a fiscal expansion, even if it can boost growth for a bit, will only make consensual debt relief more difficult in the long run. All of these ideas have been firmly rejected by Germany and by other European creditor countries, and it is likely that any debt relief offered would involve a reduction in interest rates and payment deferrals, not cuts in nominal debt, and conditional on reforms that would make relief distant at best. Further, the precedent such a deal would set makes it very difficult for creditor governments to agree, at least in the time frame required for Greece to stay current on its obligations.
Second, any compromise agreement would need to allow the incoming government to issue new debt that would primarily be purchased by already-stretched Greek banks. That would require an extension and modification of Greece’s debt program, which expires at the end of February, and expanded ability for Greek banks to finance these purchases directly or indirectly through the European Central Bank (ECB). Such forbearance will be tough politically at a time when Greece, in word if not in deed, is repudiating its past commitments. Even if the ECB continues to extend credit on Greece’s intention to negotiate, the government would likely run out of money in July or August when some substantial debt payments come due. Markets would likely move the ’zero date’ forward if negotiations lag.
The fiscal position apparently worsened sharply in the run-up to elections, as tax revenues plunged and spending rose, resulting in a smaller-than-expected primary surplus in 2014 and a deficit in early 2015. That is both good and bad for a deal. On the positive side, it allows for a fiscal path that tightens later this year but is still far less austere than the 5 percent of GDP primary surplus target under the current program—everybody wins. On the down side, it brings forward the date that the government runs out of cash and makes it harder for other European governments to endorse. Further, it raises government debt levels well above the current level of 175 percent of GDP, clearly unsustainable absent substantial debt relief. Can the IMF support this path? Navigating these issues will take a delicate balancing act, and a lot of near-term financing.
Finally, short of a eurozone exit, but absent an extension of its IMF-backed program, Greece could finance itself through arrears and, eventually, capital controls to prevent capital from fleeing. Payments, including debt payments, would be delayed. This may well be the most likely scenario in the near term. Many point to the example of Cyprus, and note that, while still in the eurozone, there would be a de facto separation—a euro in Athens would not be the same as a euro in Berlin. However, the Cyprus program was based on the (controversial) assumption that it could adjust and exit the controls with a competitive economy, a story far harder to tell in Greece. Even in the best of circumstances, controls are hard to remove. Unless you believe that, with time, a fiscal-driven boost to growth is all Greece needs to achieve longer-run competitiveness and sustainability, there would not be a path to normalization that did not involve a significant markdown of Greek debt. If that “unilateral” debt restructuring was unacceptable to the rest of Europe, it is easy to imagine that exit, even if delayed, would be the end result of the process.
My bottom line is that the new government can produce a temporary growth surge inside or outside the eurozone, but that the main scenarios for doing so make consensual debt relief harder, not easier to achieve. Whatever the longer-run consequences of the new government’s plans, an eventual exit from the eurozone seems more likely than not. While Europe is better prepared than 2010–12 for such an event, the substantial losses that would result with either exit or capital controls would have broad repercussions. Moreover, any growth in Greece will embolden anti-austerity parties elsewhere in Europe. In a year, the debate may be over whether the rest of the periphery should copy Greece, not the other way around.