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From Grexit to Agree(k)ment

Economic Report

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  • Early on 12 July an agreement was reached as a basis to start negotiations on a third support package
  • The Greek Parliament must put into law a number of specific agreements no later than Wednesday 15 July after which the parliaments of a number of other member states must agree to starting the actual process of negotiations on a package
  • In exchange for a three-year loan of between EUR 82 billion and EUR 86 billion Greece is required to implement strict austerity measures and comprehensive reforms. The text of the agreement rules out any question of debt cancellation although debt restructuring is still an option on the table.
  • Given the adverse impact on the Greek economy and the lack of consensus for the package in Greece we would have preferred to see a less stringent austerity package so that the structural reforms could be given maximum priority
  • As expected the current agreement gives the ECB enough certainty to maintain its emergency assistance to Greek banks for the time being

How things stand

On 12 July European leaders reached agreement as a basis to start negotiations on a third support package for Greece provided a number of obstacles are cleared. First the Greek leaders must obtain parliament ‘s approval for the current proposal no later than 15 July. Then the parliaments of a number of other eurozone member states must give their support before talks can resume in Brussels on the details and timelines required for implementation of a third support package.

In the weekend of 10-12 July negotiations between the Greeks and the other eurozone countries reached a fever pitch. At stake was a new rescue package of between EUR 82 billion and EUR 86 billion to support the Greeks through the next three years[1]. An extensive list of austerity and reform measures submitted by the Greeks was the basis for negotiations. Roughly EUR 12 billion is needed to tide them over the next few months in which they must repay EUR 3.5 billion to the European Central Bank (ECB) on 20 July and EUR 1.6 billion to correct the missed payment due to the IMF in June and thereby prevent an official default to the Fund. The package also covers another EUR 10 billion – EUR 25 billion to recapitalise the Greek banks which have been significantly weakened by the stress of the last months and the capital restrictions of the last few weeks.

The European government leaders are demanding action from the Greeks on a number of issues before deciding next weekend whether to open negotiations on a new rescue package. Specific measures include accelerated agreement by the Greek parliament to a simplification of the VAT system and broadening the tax base, accelerated implementation of measures to make the pension system more sustainable, and the establishment of an independent fund to manage valuable Greek assets to be used to reduce government debt. The Greek parliament must vote these measures into law no later than 15 July.

Footnote

[1] As a reference, Greece already received a total of EUR 226.6 billion in the first and second support packages.

The ‘agreement’

There have been a number of unfavourable reactions to the compromise which is being seen as a package of draconian measures which are unnecessarily humiliating to Greek honour and sovereignty. We take a more balanced view. We understand the need for radical reforms – some of which by the way were already agreed on in 2010 and again in 2012 – in order to structurally strengthen the economy. Having said that:

  • In our view if the austerity measures were less drastic they would not form too much of a block to economic growth and would increase the chance of acceptance by the Greeks. The compromise package on the table requires the Greeks to go a long way both in austerity and on reform.
  •  An absolute requirement of the Eurogroup is that the IMF remains involved in the rescue package and is given full authority to go through the policy processes and all the figures in Athens. This point clearly requires a major concession on the part of the Greeks but is understandable in the context of Prime Minister Tsipras’ current acceptance of demands which he has spent the last six months resisting with all his might. The role and authority demanded for the IMF are directly related to the lack of trust between the Eurogroup and the Greeks.
  • Greece is required to establish a privatisation fund based on EUR 50 billion of state assets. Again this is directly related to the lack of trust in the intentions and commitments expressed by Greece. However this requirement is also extremely humiliating and jeopardises the chance of acceptance of the other elements in the package.
  • In our view the total absence of debt cancellation in this package -although not unexpected - is a major missed opportunity. The Europgroup does state that further restructuring of the debt (in the form of extended repayment periods and/or even lower interest rate) can be discussed after the first implementation review, but it also states explicitly that there can be no question of debt cancellation. It is our view that debt cancellation would be a gesture which would make the package more easily acceptable to the Greeks. And it’s a gesture which costs almost nothing, because under the current conditions it’s unlikely that Greece will be able to repay all the debts in the long term.

Greek proposals plus additional demands from the Eurogroup

The stringent and comprehensive package which Greece must agree to in exchange for a third support package is based on proposals submitted by Greece prior to the weekend of 10 July. Ironically these proposals contain almost the same list of reforms and austerity measures which 61% of Greek voters rejected in the recent referendum. The same measures in fact which Europe demanded earlier in exchange for the final tranche of the second support package which has now run out. Europe however stated that this list was not a sufficient basis to reach agreement on a new third package. There are a number of reasons for this. Firstly the Greeks are now asking for a much bigger package, i.e. a three-year package costing an estimated EUR 82 billion to EUR 86 billion. Prior to the Greek referendum the issue was ‘merely’ the conditions for accessing the final tranche of EUR 7 billion from the previous rescue package. Secondly the Greek economy has been destabilised in the last weeks due to capital controls and the closing of the banks, which according to IMF estimates cost around EUR 25 billion in lost economic activity up to 12 July.

Even more importantly the Eurogroup is demanding so-called prior actions from Greece; because trust in the intentions of the Greek government has completely disintegrated, the European leaders require that the Greek parliament approves the austerity and reform measures before negotiations can start on the new rescue package.

Both the proposals submitted by Greece before the weekend and the current acceptance of the ‘offer’ from Europe demonstrate that Prime Minister Tsipras’ government has made a 180-degree shift from the ‘no’ campaign which it conducted in the run up to the referendum, against the austerity and reform conditions imposed by the previous Troika. As we stated earlier, the Greeks seemed to be moving towards a Grexit in the non-cooperative situation after the referendum. The fact that Greece has now switched to a much more cooperative approach reduces the risk of a Grexit although at the same time the risk of a Graccident (unintentional collapse of Greece banks and enforced introduction of a new currency) is growing by the day.

Banking clock ticks faster

The uncertain factor is how long the Greek banks can still hold out. The banks have been closed since 29 June, savers can withdraw only EUR 60 per account holder per day from their bank accounts and international payments must be approved by a committee of ‘wise men’ before they can be transacted. And these payments are only allowed for essentials such as medical supplies. It is reported that in the last week Greek savers withdrew around EUR 100 million each day. Based on the number of account holders and the withdrawal limit that could rise to around EUR 400 million, if they can keep the ATMs filled at least. Given that on 3 July the Greek banks indicated that they had only EUR 1 billion in cash, there can’t be much left even with the relatively limited withdrawal rate of the last week. It’s possible that the agreement of 12 July will restore some of the trust of the Greek people in the banking system, which could reduce the pace of cash withdrawals in the coming days. But given that it is still not certain whether the conditions imposed by Europe will get through the Greek parliament in the next few days, the return of confidence is far from certain.

The crucial question is: what will the ECB do? In the short term Greek banks need extra Emergency Liquidity Assistance (ELA), but the ECB has stated that it will only consider increasing its assistance to Greek banks if there is agreement on the new rescue package. As expected, on 12 July the ECB decided to maintain ELA, on the basis of the current agreement, but not to increase the amount of ELA available. The ECB may decide to increase ELA next week, once the Greek parliament and the parliaments of other member states have agreed to negotiate further on the details of a third support package. In which case the increase will be large enough to ensure sufficient liquidity for Greek banks to keep refilling the ATMS and low enough to maintain the pressure on the Greek government to reach a definitive agreement 

In summary: why do we prefer not to see a Grexit?

In the last few months in particular the personal relationships between the European and Greek leaders have hardened significantly, making it at times difficult for them to keep their eye on the ball. Which is why we think it’s important to summarise the main reasons why we still consider that a Grexit is undesirable in principle.

From an economic perspective the irreversibility of the euro will be lost for good if any country randomly leaves the currency union. In future economic crises in individual countries this could make savers and investors nervous because they will always remember that at the end of a crisis euro-exit will always be a possibility. In the current context another factor for consideration is that a Grexit could lead to political contagion to British voters who have been offered the prospect of a referendum on Brexit by Prime Minister Cameron. A Grexit could be seen by British voters as a sign of political failure and thereby damage the will to remain in the European Union. The loss of two countries from the EMU and EU respectively in such a short period of time is extremely undesirable for the stability of the European integration project.

From the geo-political perspective a Grexit and the ensuing risk of a social-economic implosion of Greece is a major risk for South Eastern Europe, a region which is already far from stable. A destabilised Greece would no longer be able to cope with the current flow of refugees from the Middle East and North Africa. And the already tense relationship between Europe and Russia could be further stretched if Greece splits from Europe and ultimately seeks closer ties with Russia.

The costs of these risks are difficult to estimate as is the moral risk associated with an overly soft approach to Greece. But it is abundantly clear that these non-economic risks are both real and significant. Acceptance of a Grexit as the outcome of the current situation should not be taken lightly.

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