Greece: A Surprising Bailout Proposal

Published on September 15, 2015

As Greek citizens head to the polls this Sunday September 20 for the third time this year, Prime Minister Alexis Tsipras’ pared down Syriza Party has been sliding from its commanding lead in the polls to a statistical dead heat with the opposition New Democracy, led by Evangelos Meimarakis.

 

The winner in the new Parliament, and new government, will be charged with implementing the tough conditions of the Memorandum of Understanding signed on August 14 with the country’s Eurozone partners – and both major parties will abide by the agreement – reducing the drama and relevance of these elections, truth be told, for broader financial markets.

 

*** But while all eyes are focused on the political campaign, we understand that the EU has been quietly studying a watered down proposal for debt relief, one of the final elements (along with the banking system recapitalization) left to fall in place for the new aid package for Greece. While this may not tip the scales in Sunday’s elections, it would undermine one of the few victories Tsipras has to show for all his contentious and costly negotiations with Greece’s creditors. ***

 

*** Namely, it appears that instead of lowering interest payments or extending maturities on Greek debt, the EU may be considering a proposal to simply cap debt service payments on Greek debt from rising above a specified level, most likely 15%, of the country’s total debt burden. Debt negotiations could be re-opened in 2022 after all parties see how the country is faring and take a measure of market conditions. Under the European Commission’s baseline scenario Greece’s interest payment burden would never go beyond 15% anyway – it gets close, but just below — but in essence, what Greece would get now would be insurance, not relief.  ***

 

*** The elections are meanwhile being watched closely in Brussels and Frankfurt, as well as by the IMF and Washington, and our understanding is that while the EU has not and will not express any preference, it does ironically hold a slight preference – for the sake of the swift implementation of the MoU – for a return of Tsipras as the head of a newly formed, more inclusive center-left Syriza government that would also include more centrist parties such as To Potami and PASOK. ***

 

*** And despite Syriza’s precipitous drop in the polls, we believe Tsipras will ultimately prevail and eke out the victory and majority needed to win the 50 seat bonus Greek electoral law provides the front runner. While Meimarakis has surprised all observers with the success of his challenge to the still personally popular Tsipras, his performance in last night’s debate did not seem to carry through the momentum of the first debate, and low turnout may hurt the protest vote as much as the incumbent on Sunday. ***

 

But that prediction assumes Tsipras is not damaged between now and election time by further criticisms and revelations about his poisoned chalice deal with the EU.

 

A Still Unresolved Wildcard

 

While there is unanimous agreement in principal among Greece’s creditors to offer some form of debt relief to Greece once the program review is complete, most likely not until November, it remains politically unpopular among creditor nations.

 

Greece already pays no interest until 2023 on its EU debt, and ESM loans are being provided at barely above the institution’s cost of funding. And ironically, the most expensive debt on Greece’s books is to the IMF, whose leadership is most adamant in pushing for a more substantial re-negotiation of Greece’s debt profile for its sustainability review.

 

But when it comes to Greece’s prospects for debt re-profiling, one of the few political victories Tsipras has attempted to claim from the negotiations, his erstwhile ally, the IMF – or at least a majority of its leadership – appear in the near term to have taken a back seat. This allows the EU to make the case for a limited, de minimis concession to Greece with a clause that would simply cap the cost of servicing the country’s debt rising beyond the threshold of 15% of the debt’s nominal value.

 

Above that would trigger a semi-automatic payment correction for any upwards deviation from the said threshold – as long as it was not self-inflicted by any failure from Athens to deliver on its end of the MoU.

 

An agreement instituting such a clause could – tentatively – be ready by the beginning of 2016, and it would be likely to include provisions that any decision to rein-in debt servicing costs to below the 15% threshold should be subject to a review to find out if the rise of the cost was due to market conditions, or to any slacking of the Greek government in the implementation of the MoU’s fiscal measures.

 

While this may seem like a reasonable solution as proposed – protecting Athens against for example unforeseen interest rate rises down the road – we believe it would be problematic not just for Athens and another humiliation for Tsipras, but it could also fall short of the re-profiling the IMF would like in order to keep its engagement in the Greek aid program.

 

The Timetable, if all Goes Well

 

In the meantime Greece still has to get through Sunday’s parliamentary elections.

 

While both major parties have pledged to work with the creditors and to uphold the terms of the MoU, the thinking in Brussels is that as Tsipras himself was the one to negotiate the program in August, having just completed a turnover in the finance ministry’s top bureaucracy, stacking the institution with his own people, he would, were he to win re-election, be politically forced to fully “own” the implementation of the measures rather than be tempted back in any way to his previous anti-austerity stance.

 

A forced coalition with the more moderate To Potami and Pasok parties would be icing on the cake.

 

And while of course Brussels would be just as keen to work with a center-right New Democracy-led coalition (some might even welcome that), a  Syriza majority is seen as more likely to shorten the MoU’s implementation timeframe, an outcome that would in the short run be a positive for markets as opposed to the greater uncertainty of a complete reversal back to an ND-led government.

 

Once the elections are over, barring unforeseen surprises, the first Program review is likely to start between the first and the second week of October and will probably last a month or so.

 

Its completion will hopefully be followed by the re-entry of the IMF back into the picture, but only following a revision of the MoU to meet the IMF requirements on the fiscal side. That would push the official date of the renewed IMF involvement in the program towards mid to end December 2015 – assuming all goes well.

 

The disbursement of the three billion Euros or so left from the first bailout tranche should occur around early October, following some more measures that will need to be passed by the Greek Parliament once the election cycle is over. The disbursement of the part of the first tranche provided for the recapitalization of Greek banks will – we understand – then happen once both the Asset Quality Review and the first program review are over.

 

Our base case is that the AQR won’t be completed and money for banks disbursed until year-end. But some consolidation in the banking sector might still be needed, and that could complicate the banking review as EU competition rules could then need to be involved.

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