It should be no surprise that eurozone finance ministers failed to agree to disburse €2 billion in bailout money to the Greek government today or to release bank recapitalization funds. Despite optimism following the recent announcement of a relatively benign program for recapitalizing Greek banks, it is hard to escape the conclusion that the Greek program again is headed off track. The government has fallen behind its reform commitments, and a substantial number of additional end-year measures look unlikely to be met. Even with substantial forbearance from Greece’s European partners, it now looks likely that conclusion of the first review of its program will be delayed and that the promised debt relief negotiation will come only in 2016. Further, an eventual International Monetary Fund (IMF) program is likely to be small and leave a large unfilled financing gap that will further strain Greece’s relations with its European neighbors. It is hard to predict how long Greek voters will continue to support a government that cannot deliver on its economic pledges of low debt and sustainable growth.
The European Union (EU) bank audit results revealed a capital need of €14.4 billion in an adverse scenario (€4.4 billion in the baseline), which conveniently looks to be consistent with previously approved bank recapitalization funding from the Hellenic Financial Stability Fund (HFSF). While the downside scenario is not an exit scenario—the capital needs would likely be far greater if Greece were to exit the eurozone (and Greek bank capital still relies on deferred tax assets to an excessive and credibility-destroying extent), it does cover a substantial renewed recession that would result from a protracted standoff with the IMF and its European creditors. The push is now on to complete the recapitalization by year end, raising private capital to the extent possible before state aid is drawn on, before new EU rules go into effect that would require a greater haircut on bank creditors as a condition of state support (there is a certain irony in hearing policymakers celebrate the evasion of these new rules once seen as critical to the credibility of EU banking union).
The next step in Greece’s reform effort is the first review of the August European Stability Mechanism (ESM) program, which is a condition for further disbursements under the package and, more significantly, required for starting the negotiation of debt relief. Reports today suggest disputes remain on a new foreclosure law, the VAT on private education, and pricing of non-generic medications, as well as on the timing and pace of pension reform. Individually, each of these problems would appear solvable if the government has the will to move forward, but the growing list of unmet commitments has raised concerns among creditors as has the request by the Greek government for a "political decision" on the review.
Much was made over the summer on the dispute between the IMF and Europe on debt relief for Greece, The United States now is also pressuring the eurozone on debt relief for Greece. While the announcement of debt relief could maintain domestic support within Greece, the ultimate success of the program is still uncertain. Whether Greece receives haircuts (what the IMF and the United States would like to see) or further deferral of interest payments (the German proposal) will only affect what Greece has to pay after 2022. In any event, the extended window of very low debt payments to official creditors creates temporary space for private issuance, but this type of seniority-driven market access is not durable and will require repeated official debt service extensions. Despite this issuance, in the near term there would appear to be substantial funding needs for the Greek government. The fiscal position has returned to deficit (taking into account accumulated arrears) and growth is likely to remain muted at best. The current IMF forecast is for growth (year-over year) to turn positive only in 2017.
It is easy to be critical of a reform program that contains so many reform measures, and arguably a lack of institutional capacity within the Greek government limits their capacity to move forward. But at the same time, there cannot be a return to durable growth within the eurozone without a major transformation and opening of the Greek economy, and creditors are increasingly frustrated with the slow pace of the Greek government in meeting its commitments. Ultimately, “Grexit” will become an option again when Greek voters lose patience with the current path being charted by the government. It is hard to predict when it will happen, but hard to imagine another result.