A successful conclusion of the bailout program for Greece agreed to at the political level last Monday is predicated on the successful completion of four major, and contentious, steps, the first hurdle of which was largely passed today, with another vote still to come on July 22.
One: First Round Votes and Liquidity Measures
The first step was the immediate ratification of Monday’s agreement in both the Greek and creditor countries’ parliaments. On the Greek side, ratification committed Athens to the implementation of the reforms agreed to at last weekend’s meeting, while on the creditor side, ratification signals a commitment to a three-year estimated 84 to 86 billion Euro ESM-backed program, critical details on which remain yet to be agreed.
** As we have been flagging for some time, despite concerns over the power of the left wing of Syriza and a potential revolt that could throw the Greek government into turmoil, the first round of votes on Wednesday night passed only with only a relatively modest 32 defections from the Left Platform, a rather limited number that we had been expecting.
** While these defections clearly introduce an element of political and implementation risk on the Greek side, it remains again, as we have been expecting, close to a guarantee that Alexis Tsipras will remain Prime Minister of Greece not just in the interim period, until a Memorandum of Understanding is signed with the creditors, but also after elections that may be held in September, if not October or even later.
** A successful conclusion of negotiations will only further play into Tsipras’ hands, with political risk in Greece in reality stemming from a complete collapse in talks, rather than any sort of internal rebellion against the program.
** Tsipras confirmed his intention to continue passing legislation under a minority government, and that any notion of a government of “national unity” forced by creditors onto Greece under some sort of technocratic leadership, a la the earlier government led by Lucas Papademos, is simply not going to happen – that is just so 2012.
** In the meantime, despite continuous market skepticism over Tsipras’s true motives and colors, we still think Tsipras, as opposed to being defeated by his left wing, will survive his “cave-in” to the creditors and attempt to leverage his still substantial personal popularity and consolidate his position by embarking on a limited reshuffle of his cabinet to purge the most extreme defectors of his party, including first and foremost energy minister Panagiotis Lafazanis, the leader of the “Left Platform,” which is now all the buzz in Athens.
** From what we understand, Tsipras may however choose to take a lighter touch – at least for now – on the rebel parliamentarians, at least until after the second round of votes that needs to be passed by July 22.
** While a cabinet reshuffle is clearly a necessary signal to creditors and to his own party of his government’s reluctant ownership of the program, the replacement of parliamentarians such as the ultra-radical Speaker of the Parliament Zoe Costantopolou, also squarely in the crosshairs, may prove more problematic and perhaps even unnecessary in the very near term. We are also warned that the next round of voting may elicit resistance from new, rural constituencies within the Parliament, given the legislation will also target agricultural interests. But we nevertheless expect the July 22 vote to pass easily as well.
** On the heels of the agreement, the creditors have reached agreement on the liquidity front on a seven billion Euro European Financial Stability Mechanism interim funding program that will allow Greece to pay their arrears to the IMF, and could help meet some but not all the upcoming near term debt bullet obligations to the ECB.
** But while the ECB yesterday also did its part in providing some desperately needed additional liquidity to the Greek banking system, raising the Emergency Liquidity Assistance authorization to the Bank of Greece by 900 million euros, both the ECB and EFSM liquidity measures are nevertheless still tight and will keep intense pressure on all sides to negotiate a broader program as expediently as possible.
Two: Banking Analysis and Assessing the Real Size of the Hole
The second step, happening concurrently, will be a wholesale re-assessment of the Greek banking system to determine the real size of the hole that needs in fact to be plugged.
** While much of the market focus has been on the capital flight out of the Greek banks, EU officials are equally concerned with the damage done to bank balance sheets on Non-Performing Loans after what has been eight long months ongoing turmoil, uncertainty and economic contraction.
** The challenge for policymakers here will be one of timing – a full review will take months to complete even as it is in both Greece and the creditors’ interest to reopen the frozen banking system as soon as feasibly possible.
** Despite the provision of short term liquidity we therefore continue to expect the lifting of capital controls and an easing of liquidity measures by the creditors and ECB to be a gradual, protracted process rather than an immediate one.
** We also continue to expect a bail-in of equity and unsecured debt on parts of the banking system as an end result of the banking assessment process. That process could also result in the establishment of a bad bank to house the new stock of bad NPL assets.
Three: Debt Re-profiling, Sustainability, and the Final Bill to the EU and IMF
The third element required to fall into place for a final deal is an agreement on the exact nature of the debt re-profiling for Greece that everyone has signed off on in theory, but whose extent and the details of which are still very much in dispute.
** It is clear and has been clear from even before the January elections that swept Syriza into power that a haircut on the debt principal would be off-limits to the EU, and frankly the Tsipras administration has never whole heartedly expected or demanded that, even with the IMF’s sustainability analysis supporting their case for as aggressive a “re-profiling” as possible.
** The real issue will be creditor concerns led by Germany, Finland and the Netherlands, that a “re-profiling” could in effect be seen as a “backdoor haircut.”
** Nevertheless, despite such warnings from German Finance Minister Wolfgang Schaeuble, both the Chancellery and Finance Ministry in Berlin have taken pains to “clarify” that their red line so to speak on a re-profiling would be to limit a cut to the loans’ Net Present Value that would result from a lowering of interest payments and extension of maturities, rather than avoid it altogether.
** In other words, that ship has long sailed, but a deal on the debt sustainability review and the depth of the debt re-profiling will still ultimately matter for the involvement of the IMF.
** And here, despite the public positioning that continues and will continue until a final deal is reached, we would flag what we believe is an early indication of a potential technical compromise in talks between the EU and IMF that has garnered little attention, but which could be critical in reaching the all-important final compromise on a debt sustainability re-profiling for Greece.
** Our understanding is that the IMF has indicated a willingness to incorporate Greece’s debt to deficit calculations in its sustainability analysis, in addition to its traditional debt to GDP benchmark.
** That would be a significant concession to the EU position that Greece does not have an unusually acute problem on an ongoing deficit financing basis, the problem rather being the enormous overhang and the eventual repayment of its principal, which is largely the focus of the traditional stock of debt/GDP analysis.
** And that eventual repayment of principal would even be less of an issue if and once the maturity of the loans are extended well beyond the lifetime of any politician or perhaps even of our clients’ distribution list, at which point one might hopefully assume Greece has implemented and bounced back from the recessionary impact of its reforms, and perhaps even returned to a relatively reasonable and fiscally sustainable growth path.
Four: The Final Memorandum Vote
The final, and fourth step will be the conclusion of the Memorandum of Understanding and its ratification of the full deal, with numbers firmly in place, through the relevant parliaments, Germany in particular.
** And here, the nature of the Bundestag’s vote earlier today may come into play. While German Chancellor Angela Merkel will no doubt be pleased with the outcome of some 439 yes votes, well over the majority needed, a few points from today’s vote may be worth considering for down the road.
** First, the number of dissents from Merkel’s own center right Christian Demcorats or Christian Social Union was 60 (47 CDU, 13 CSU), or nearly double the number who opposed her in February on the last bail-out.
** Second, and more importantly, while only five Social Democrats voted against the government today, our sense is of deepening fissures within the SPD and a potential challenge to the SPD leader and Vice-Chancellor Sigmar Gabriel over his handling of the negotiations.
** In particular, there is considerable dissent within the SPD ranks over the way he was unable or unwilling to stand up more forcefully to Finance Minister Wolfgang Schaeuble’s “time out” Grexit tact, or that Schaeuble even repeated that Grexit was probably “the better way to go” for Greece right up to the Bundestag vote, or insisting that Gabriel knew all along and fully supported the idea.
** And of course, the vote today was only that the negotiations for the third Greek bailout can proceed, but if there are any major stumbles on the MOU or in the ability of Athens to hit its tough fiscal and reform targets, we suspect the splits within Merkel’s Grand Coalition will widen and become more public.
** The gravest risk to Merkel, we think, will contrary to common perception not be from her right, but from her left, and in the SPD seeking to distinguish itself more clearly on European issues, especially with the 2017 federal elections looming on the political radar screen.