Political Economy

How to look at the Greece bailout deal

By Edward Harrison

Yesterday, Greece received an agreement in principal to extend its existing bailout program for another four months from the institutions administering that program. I believe this deal is a good basis for further work down the line. But Greece has a lot of work ahead of it, if it is to move to a new program. Moreover, Syriza will have to sell this deal as a bridge to the sustainable economic outcome it sold to its electorate in the January elections. At the same time, the Germans and the Finns at a minimum will have to sell this deal to their parliaments for it to work. Some thoughts below

Let me say off the bat that the political dimensions of this deal don’t really concern me except to the degree they are relevant for likely economic and market outcomes. I am not a political analyst. So I don’t really care about the politics. But, of course, the politics are definitely relevant and in some cases the driving force of economic outcomes. So I am forced to factor this into my analysis. But what I am driving at here are the answers to two questions: 1. what are the political and economic constraints that are foreseeable? and 2. what are the likely market and economic outcomes given those constraints?

On the second score, we do not have a clear picture yet because we have only seen a deal in principal. The keys will be what reforms are implemented, how well Syriza does on the tax collection front, and what degree of flexibility Syriza get in terms of the 2015 budget. The best case scenario is enough pro-growth reforms, tax collection and flexibility that Syriza wins over the Eurogroup, EC and ECB such that a new deal with debt maturity extensions and interest rate reductions is crafted in June. The worst case scenario is that trust breaks down between this Greek government and the Troika, forcing Greece to default sometime later this year.  

From a eurozone-wide perspective, the reduction in oil prices is helpful to general eurozone economic growth prospects for this year and I believe most of Europe will see upward revisions in GDP numbers. But, otherwise, the policy strait jacket in Europe will remain and that means economic under-preformance, continued low rates, and continued low inflation or negative price level changes (CW Pro readers, see my full comments here from December) 

The deal we are seeing now is in line with what I expected. First, when Syriza came to power, the following day I wrote the following at CW Pro based on what I saw as best alternatives to a negotiated agreement in both Greece and Germany in particular:

“Herein lies the only area for agreement then:

  • No debt writedown: only maturity extensions and interest rate reduction. From the Troika perspective, a principal reduction looks to be a non-starter. Finland has said so, and the Germans have said so. They do appreciate that the vast majority of Greek debt is in public hands, meaning that contagion from a writedown may be limited. But I don’t think the ruling coalition in Germany could get approval on this in parliament or in opinion polls.
  • Back-loaded austerity: although stimulus is the opposite of austerity, Syriza could still get some stimulus in the short-term if they commit to reforms and a plan that has the deficit and debt numbers moving toward the Maastricht criteria over time.”

I have put this 26 Jan post up on the blog site now. You can read it here. The point I want to make now is that even though a lot of people are focused on who caved or climbed down from their negotiating position and electoral promises, if you looked at all of the economic and political constraints from the day Syriza came to power, you would have determined that those positions were not defensible. There was no way ever that Syriza was going to get a debt writedown. It’s not clear whether they understood this and just needed to set that as the bar, but my read of the German (and Finnish) positions is that writedowns are a non-starter (at this time). Moreover, despite what the Germans were saying about deficit targets, given what we have seen in Spain, France and elsewhere in previous negotiations and given what occurred a decade ago with deficit breaches in France and Germany, it was always likely that there would be flexibility on deficit targets.

Second, three days ago after the earlier disaster on 16 Feb, I wrote another CW Pro post that I have since put on the blog site here that I think works for thinking about policy decision analysis. The gist of that post is that political incumbency usually infers risk aversion and that means making decisions that reduce uncertainty. The decision to allow Lehman Brothers to fail without a plan in place is the exception that proves the rule because it demonstrates to everyone what type of really poor outcomes can result when uncertainty increases.

I concluded that piece by writing then that “I believe this Moscovici option, which is basically a 4 to 6-month bridge loan without a clear commitment to a Troika program, will now anchor further discussion and the Eurogroup finance ministers will be forced to take it with minor caveats or risk the fallout of Greek default. I don’t think the language I am hearing from the Troika says they have backed themselves into a rhetorical corner. There is wiggle room for a deal that is consistent with past policy stances on both sides. Only if the Troika can convince themselves that black swan events are almost certain not to occur if Greece defaults will we see them reject a deal with Greece. Otherwise, a deal remains the base case outcome.”

What we ended up getting was anchored by the Moscovici plan in my view. And it points to how important he was to building trust and consensus in this process and making a deal happen. The following points stand out for me

  • The deal is 4 months after Varoufakis requested 6. I told you on Wednesday to expect 4 to 6 months because that is where the anchor was.
  • This deal has what Varoufakis described as “constructive ambiguity” in its commitment to a Troika program, which is important in selling it as delivering on electoral promises. The 2015 budget target is now “flexible” and depends on the circumstances on the ground. And Greece is able to table the 70% of reforms it supports and reject the 30% it doesn’t, with ultimate review by the Troika. Some of my tweets and retweets from when Varoufakis gave his press conference give you a better idea of what I mean.
  • This deal commits Greece to the existing program with no debt writedowns, which is important in selling it to the German Bundestag. I listened to Wolfgang Schäuble’s press conferenc ein German after the Eurogroup press conference and he made a number of remarks I felt were telling on that score.

In short, Greece gets fiscal target flexibility and a line by line reform list review. The Eurogroup gets a commitment to the existing deal in full for four additional months.

Going forward, Greece will submit its list of reforms for approval to the Troika and the Troika will have to iterate back and forth with Greece to get this list approved. After Monday, Greece and the Troika have until the end of April to finish off the finer points regarding reforms and targets for this deal to become etched in stone. Lagarde was at pains to point out during the press conference that the IMF is bowing out in March 2016. And I get the sense that this is by design and mutual consent. Going forward, this will become an EU affair and the IMF will not be as integrally involved. From what I understand, however, Lagarde was just as helpful as Moscovici in diffusing tension between Germany and Greece as well as tamping down on the opposition from centre-right governments in peripheral Spain and Portugal who have signed up for austerity and reforms already. The IMF will be missed.

Bottom line: there is enough flexibility in this deal that both sides can declare victory. Let’s see where we are in 4 months. From a market perspective, I expect risk-on mood to re-assert itself now. And with the tailwind of lower oil prices, that is supportive of equities and the lower rated sovereign debt in the eurozone.

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Edward Harrison 7783 posts 575 comments

Edward Harrison is a senior Editor at Bloomberg. He is also the founder of Credit Writedowns newsletter, a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

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