Greece: Structuring and Selling a Marginal Deal

Published on February 13, 2015

For all the tough rhetoric from Syriza party leader Alexis Tsipras, the broad outlines for a potential compromise deal with the EU to renegotiate Greece’s bailout program had already been telegraphed well before the January 25 elections that swept him into power.

*** Specifically, we noted at that time a developing tacit agreement from all sides on three overarching points, that: when push came to shove the EU would show some (limited) flexibility to restructuring Greece’s debt profile; Syriza would drop its insistence and campaign promise of an outright haircut on its official sector loans, and; the EU would accept some greater flexibility on austerity and reforms as long as Greece kept to a reduced primary budget surplus target (as suggested to us) of around 1.5% (see SGH 1/12/15, “Greece: Syriza and its Eurozone Partners”). ***

*** Despite the week just finished of bombastic speeches to parliament, verbal brinkmanship, and the drama surrounding Wednesday’s opening round of discussions between Greece and its Eurogroup partners, we have no indications from any of the parties involved that those three overarching principles for getting to a deal are in jeopardy. ***

*** Greece will get and agree to some modest changes to its budgetary targets, will not go bankrupt over a 10 billion Euro “extension” — call it what you may — but nor will it get anything beyond a marginal improvement to its debt profile when a deal is finally concluded (see below). ***

The negotiations still to come will clearly be tough, complex, and take some time to conclude as EU and Greek officials meet today and over the weekend to define the still significant differences over how to reach an agreement within the framework of those three broad points.

But indeed the negotiations have to be contentious, almost by definition, to be sold successfully to the political constituencies at home — on both sides of the table.

The Broad Points of Agreement

Just today in an interview with the German press, Greece’s Finance Minister Yannis Varoufakis reiterated the contention that an outright haircut on Greece’s publicly held debt would not simply be a “gift” to Athens, but would indeed be preferable to creditors compared to the alternative of a debt extension since it would, he argued, greatly enhance Greece’s ability to pay back its debt.

What was missing anywhere in those comments, however, was a less than subtle threat that the demand for a haircut could turn into a red-line of sorts for Syriza.

Indeed, the only real explicit “red lines” Syriza has set since coming to office have been red herrings, in effect pushing on an open door as far as the EU is concerned, namely “demanding” that Greece’s primary budget target be lowered to 1.5%, and a pledge the new regime will never, ever accede to further, meaning greater, austerity measures.

Well, ok….

As to the politically all-important and potentially explosive pledges Tsipras has made on the budget, including promises to roll back layoffs, reverse pension cuts, and hike minimum wages, even those have all been framed within the context of the 1.5% primary budget “demand.”

Furthermore, Tsipras has been careful to leave a door open to a phasing-in or compromise on the timing of implementation of some of those measures. And while those budgetary negotiation with the EU will not be easy, so long as the proposed measures are within the broad framework of EU rules the arguments will be over details that can be settled later, and for which the Eurozone will be sure to show some (limited) flexibility.

Setting the Stage for Talks

In the meantime, the proposals put forth yesterday, including the “four point plan” from Athens leaked to the press, focused first and foremost on finding a temporary financial arrangement for Greece to fund itself beyond the expiration on February 28 of its current bailout program and to allow time for fleshing out a longer term agreement on Greece’s debt profile and budget.

But those proposals went nowhere after Athens refused to publicly agree to the principle that any bridge money would come within the framework and with the explicit endorsement of the terms and conditionality of the original EU program. What’s more, any future negotiations would come with a pre-commitment by Greece to future actions.

Despite that failure to agree to “pre-conditions,” the offer for assistance is still there, and Athens is well aware of how far it can push the EU.

And so the frankly silly charade has now begun to define whether the “Troika” is now called the “European Institutions,” or something else, and whether any offer of temporary assistance is defined as an extension or part of an “old,” “new,” or “revised” program.

More importantly, the working assumption on all sides is that the political fight over semantics will be settled, and the more substantive study to begin the process of determining the differences between the two sides, and the room to negotiate on concrete, financial, loan and budgetary proposals has thus begun.

Finding the Short Term Money

While the Eurogroup countries stand ready to assist Greece, from what we understand Berlin is reluctant to fund anything beyond a very short term bridge, as opposed to a six month proposed bridge that has been requested by Greece and widely assumed in media reports.

If and only once Tsipras can provide the EU with sufficient comfort on the conditionality side, there is an openness to considering Greece’s proposals to release 1.9 billion Euros of the ECB’s SMP bond purchase program profits it claims as “rightfully” its own, and even for the disbursement of additional funds.

But covering a six month “temporary” bridge we are told is seen to carry simply too high of a price tag for the creditor countries in covering the hump of additional redemptions of ECB bonds in June and July, as opposed to getting Greece over the hump of the 4.3 billion Euros of redemptions coming up before the end of March.

Greece’s proposal to increase a 15 billion Euro limit on its T-bill issuance by 8 billion Euros, to 23 billion, to give room for Athens to temporarily fund itself as it renegotiates its debt is problematic not just for the EU, but more importantly for the ECB as well, even though the ceiling is not set by the ECB, but by the Troika.

With the original program now all but dead, the ECB has already stopped accepting Greek T-bills as collateral. It has rather authorized the Bank of Greece to accept Greek bonds as collateral on its own balance sheet under the Emergency Liquidity Assistance program.

After yesterday’s failed talks, and in response to a potential strain on Greek bank funding, the ECB increased its ELA cap from 59.5 to 65 billion Euros. While this action has served to reassure markets, the size of the increase was also modest, and it also serves as a reminder to the Greek authorities that the ECB, while making every attempt to avoid ever being put in the position of having to make the momentous political decision of pulling the plug on Greece’s financial solvency and membership in the Eurozone, nevertheless needs to tread carefully when it comes to its mandate.

That pressure is not lost on Athens.

The ELA is very explicitly allowed only to be extended to fund solvent banks, and is specifically prohibited from being used as a means for monetary financing of governments. Even if Greek banks were to remain solvent, an obvious daisy chain proposal for the government to issue T-bills that Greek banks would be forced to absorb would prove extremely problematic on that basis.

Furthermore, while the ECB and EU authorities are careful to stress that Greek banks are in relatively good shape, the newly formed Single Supervisory Mechanism has also warned Greek banks not increase their T-bill holdings beyond the current limits.

All that of course can change under a new, revised, extended, whatever you may want to call it, agreement, but clearly the “go alone” route for government issuance by Athens does not exist.

Negotiating the Long Term Debt Profile

When it comes to the actual debt negotiations, there will be some room for compromise, but some of the proposals to date from Athens will simply not fly.

For one, the proposal to convert the Greek bonds held by the ECB into perpetual bonds is an absolute no-go.

Even suggesting the ECB lend money in perpetuity to a sovereign member state waves the red flag to accusations the central bank is embarked on the monetization of member nations’ debt.

In theory the ECB bonds could be sold to the ESM and then renegotiated, but that all costs money and entails the additional and politically problematic fiscal commitments from member states as well. Regardless, ECB holdings, at around 20 billion Euros, are a small part of Greece’s debt, and they could just be left alone. The much bigger negotiation will be over the terms of the bilateral, IMF and EU/EFSF loans.

Those come out to roughly 240 billion Euros, 73 billion from an original 2010 program, and 164 billion from the second 2012 aid package (145 billion of which are from the EU/EFSF and 19 billion from the IMF). Almost all of the program loans have to date been disbursed, except for a remaining 3 billion from the EFSF and 7 billion from the IMF.

Greece has proposed, in addition to lengthening the maturity and moratorium terms on these loans, and lowering the interest rate charges, to index payments on the non-central bank debt to growth targets, or “GDP linkers.”

The concept of indexing payments to growth is not being rejected out of hand by creditors, but we are told it is more complicated and controversial than may seem on first blush.

For one, memories are still fresh in Europe of the manipulation of the economic data and statistics that showed Greece qualifying on the Maastricht agreement criterion for Eurozone membership in the first place, complicit as all parties may have been to that farce at the time for political reasons. And creditors do not have a particularly pleasant historic experience of indexed loans with Argentina, where the government brazenly manipulated its inflation data when it came to ponying up on inflation indexed bonds. Presumably, the Eurostat is a much more credible and solid institution now than it was then, and Athens will not follow the path of Buenos Aires.

There is also an issue with moral hazard when it comes to indexing payments, or perhaps more aptly phrased in the creation of perverse incentives, namely in linking the negative near term burden of higher repayment of debt to the positive goal of faster GDP growth. We believe some sort of indexation could nevertheless be considered as an option.

But whether indexed or not, we suspect a final deal, when it comes, will be a modest one that provides limited relief in real cash flow terms to Greece. It after all has to pass muster not just with the Greek electorate, but with the EU as well, including the parliaments of Germany, the Netherlands, Finland and Slovakia.

The 73 billion Euros of loans granted in the first 2010 loan package already come on tremendously generous terms, on a 30-year term basis, with a payment moratorium for the first ten years of the loan, and carrying a 1% interest rate. The 164 billion euros of the 2012 program are on similarly generous terms, carrying an average maturity of 32.5 years, with a moratorium through 2023, and an average interest rate of 2.7%, according to the figures compiled by the IMF and the ECB.

There is room for improvement on all that, but not much.

The political challenge ultimately for Alexis Tsipras will be to declare victory and to sell what will in the end most likely be modest concessions on budget negotiations and loan terms to the Greek population.

That has, ironically, been made all the more easy by the tough reforms, and budgetary improvements set in place by his maligned predecessor, the bottoming and gradual recovery of the Greek economy, and the reality that the Greek electorate, truth be told, fully understand that there is no way Syriza will in the end get all it has promised.

And with that backdrop they will likely prove more than ready to live with such compromises as a price to pay for staying in the Eurozone.

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