Greece will get the next tranche of funding
September 22, 2011 7 Comments
The troika is threatening to deny Greece more funding unless the country meets the terms of its bailout programme, protestors are gathering in Syntagma Square and Greek prime minister George Papandreou faces significant opposition within his ruling party.
It feels like June all over again.
Everyone is waiting with baited breath to see if the Greek government can pass and implement enough reforms to appease the troika over the next few weeks. However, it is in no one’s best interest for Greece to default next month. Unless domestic political wrangling in Greece precludes the government from passing any further austerity measures, Greece will get more funding in October and disaster will be averted until December.
Austerity…the definition of insanity
The troika dramatically departed Athens earlier this month and insisted that Greece will not get the next tranche of funding unless it manages to fully implement the terms of the bailout agreement.
With GDP falling by more than expected in the second quarter of 2011 and tax revenues much lower than stipulated in the memorandum of understanding (MOU), Greece’s primary deficit has actually risen in January-July 2011 compared with the year-earlier period. The bailout programme is clearly not working.
At the troika’s insistence, prime minister Papandreou has been busy meeting with cabinet members to discuss further austerity measures to be implemented over the next few years. These measures include a property tax (applied to electricity bills) but reportedly focus more on cutting spending than on boosting revenues.
According to Albert Einstein, the definition of insanity is to do the same thing over and over again and expect different results. By this token, EU leaders have clearly lost it. More austerity measures and structural reforms will not all of a sudden succeed where others have failed.
If further austerity measures are not going to help, why is the troika demanding that Greece adopt them? EU leaders need an excuse to present to their domestic electorates for why Greece deserves any more EU/IMF funding.
In the absence of this funding, Greece will run out of money in mid-October. If Greece were to undergo a disorderly default on its government debt, there would be rapid contagion throughout the eurozone.
The larger peripheral euro area countries Spain and Italy are already under significant pressure in the markets. Italian bond yields are already at unsustainable levels, and Italy must service around €120bn in bonds and T-bills by the end of the year. Contagion from a disorderly Greek default could freeze Spain and Italy out of the markets. These two countries are far too big to be bailed out.
Motivation to kick the can one more time
Furthermore, the impact of a disorderly Greek default on the European banking system—and particularly on German and French banks—would be severe. There have been several indications that the European banking sector is in big trouble without even factoring in a Greek sovereign default. According to the Bank for International Settlements (BIS), German banks held around US$14bn and French banks around US$13.5bn in Greek government debt as of end-March 2011.
If Greece were to default on its government debt next month, the French and German governments would have to recapitalise their banks. However, if the troika transfers the next tranche of funds to Greece, the country will be funded through December.
By this time the reforms to the European Financial Stability Facility (EFSF) agreed in July will have been ratified by individual euro area national parliaments. One of these reforms is to allow the EFSF to recapitalise European banks directly.
By providing Greece with the next tranche of funding in October, EU governments effectively shift the burden of recapitalising their banks to the EFSF should they choose to withhold subsequent bailout funding from Greece.
The biggest risk to the next tranche of funding is from Greece
With the creditor countries clearly motivated to avoid a disorderly Greek default at least until December, the only reason the troika might refuse Greece funding next month is if the Greek government does not play ball.
Further austerity measures in Greece will have to be approved in parliament. The measures might pass, but it will depend very much on discipline in the ruling party, the Panhellenic Socialist Movement (Pasok). The last set of austerity measures put to a vote in parliament—the medium-term programme in June—barely passed even after the government cabinet was reshuffled. Since June, divisions within the ruling Pasok have widened.
It is by no means a foregone conclusion that further measures will be passed. If the Greek government cannot agree on steps to appease the troika, Greece could simultaneously face a disorderly default and an early election. This would be such a disaster for Greece, I think the government will manage to agree to meet at least some of the troika’s demands.
December…all bets are off
While funding will be forthcoming for Greece in October, this is only likely to buy a brief respite for Greece. With profound divisions within Pasok, constant bickering between Pasok and the main opposition party New Democracy and significant public opposition to further austerity and structural reforms, it will be nearly impossible for the government to implement more measures even if it manages to pass them.
Greece is stuck in a negative feedback loop, whereby contracting economic growth undermines the government’s attempts to rein in its fiscal dynamic, and this loop will not be broken in the next few months. When the troika descends on Athens once again in December to evaluate the government’s progress in meeting the terms of the bailout, we will see more drama. The troika is motivated to delay a disorderly Greek default for now, but all bets are off in December.