The Next Act in the Greek Drama
Last weekend the ongoing drama of Greek politics and that nation’s place in the eurozone entered the next act. The far-left Syriza party won a decisive victory in the early election, coming in just shy of an outright majority in the Greek parliament. While the size of the victory and Syriza’s choice of coalition partner caused some angst—Greek bond yields jumped around 60 basis points immediately after results were announced—the damage to financial markets was limited. No other European markets experienced a sell-off. This rather muted reaction is in part due to the European Central Bank’s (ECB’s) new €1-trillion-plus asset purchase program serving as a sort of backstop for contagion risks.
With the Greek election over, market attention will now turn to how the new government manages their debt negotiations with the troika—the ECB, European Commission and International Monetary Fund. Here is a breakdown of what is at play and what to look for in the coming weeks.
The gap between Greece and its creditors. At around 180% of the gross domestic product, Greece’s debt is unsustainable over the long term. Newly minted Prime Minister Alexis Tsipras campaigned on the promise of seeking a write-down on the country’s debt, a “haircut” so to speak, which many European finance and government officials have dismissed as out of the question. A more likely offer from the troika: a deadline extension for Greece to qualify for its next bailout aid installment.
Because of the heavy borrowing that led to Greece’s financial crisis, running a budget surplus was one of the conditions of the European rescue program in 2010. The new government wants the troika to lower this requirement of surplus to a balanced budget, freeing up cash for more government spending. In addition, structural reforms have been points of contention, with the troika wanting to see more labor market flexibility and market competitiveness, while the new coalition is looking to ramp up government hiring and increase the social safety net.
Why meet halfway? A high level of friction and difficult negotiations between the two sides would not surprise us, but there are great incentives to compromise. Despite the strong anti-austerity sentiment, most Greeks want their country to stay in the currency union. What also hasn’t changed: Greece needs access to international funding. The ECB could potentially purchase Greek sovereign bonds down the road—assuming Greece remains faithful to the outlines of its reform program—as part of their new quantitative easing initiative, thereby lowering borrowing costs and providing more liquidity to Greece. That said, it is also in the best interest of Europe to make some concessions, so to avoid the contagion risks associated with a Greek exit from the eurozone.
Structural reforms at risk. In my opinion the real risk is less about an imminent exit by Greece, and more about the limited reforms being dialed back or reversed. The new coalition government has already suggested reversing several reforms introduced by the previous administration, which in itself is a dangerous proposition for the country, but the implication for the Continent could be greater and graver. As anti-establishment and populist parties rise in other peripheral countries (the Spanish election is up next), we worry that a step backward in Greek reforms could be the beginning of more reckless reform abandon. For now, fears of a Greek exit are being held in abeyance. That is probably reasonable. But if the price of Greece staying in the eurozone is a reversal of much needed reforms, it will still count as a loss for Europe.
Key dates to watch. Mid-February: The European Union is likely to grant an extension to the bailout timetable. End of June: When bond payments to the ECB come due.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock.
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