Macro and Markets

The Greek parliament last night passed the first package of measures required by the government’s agreement with European governments reached over the weekend, winning 229 of 300 votes in the parliament. There were a large number of Syriza defections (39) that would appear at minimum to require a cabinet reshuffling. Some local analysts predict the government could fall, though most expect that if that happened Prime Minister Tsipras would reemerge as prime minister in a new coalition government. These are only the first steps on a very long path for Greece, and the tight timeline for passage of comprehensive legislation suggests political paralysis is an unaffordable luxury. Passage of first stage measures will set the stage for a €7 billion bridge loan--likely from an EU rescue facility (EFSM) if objections from non-euro members can be overcome--that would allow Greece to meet external debt payments due Monday. More significantly in the near term, the ECB is expected to expand emergency liquidity assistance (ELA) on Thursday, which will ensure there are euros in the system. But these measures are not sufficient to reopen the banks, or reactivate an economy devastated by the crisis. To take that critical next step requires an agreement on an program with European creditors that would provide €40-50 billion in financing from the European Stability mechanism (ESM). The notional deadline for that agreement appears to be mid-August, when another round of external debt payments loom, but domestic pressures on the government to reactivate the economy ahead of the ESM disbursements is one of the most significant threats to the process and one of the central scenarios whereby the government chooses Grexit over remaining within the eurozone. The third piece of the Greek package, financial assistance from IMF, has drawn a lot of attention following release by Fund staff of a new debt sustainability assessment showing that the proposed policies, even if fully implemented and successful, would lead to debt levels close to 200 percent of GDP and gross financing needs of over 15 percent of GDP. The IMF suggests that, for a Greek program to make sense, it needs to include nominal haircuts or very long grace periods on payment (as much as 30 years). The IMF’s document has been read by some as suggesting the Fund will not lend if these levels of relief are not delivered. I’m skeptical. Ultimately the Fund will find it extremely hard to say no when its major shareholders are so committed to the program, even if the program doesn’t meet the Fund’s internal rules (including a high probability that the debt is sustainable). Nonetheless, the IMF is right to be concerned about both financing and debt, and of being pulled into a financing arrangement that it does not believe in.  On the financing side, the gap is set at around €85 billion, and could well be higher with normal slippages and hidden losses in the banking system.  With only around half the financing coming from the ESM program, and seemingly unrealistic assumptions including €50 billion from privatization, there would seem to be substantial risks of a unfilled gap that the IMF would be pressed to fill. In the IMF’s current Greek program, there is €16.4 billion that is undisbursed and available between now and March 2016. But a new program now looks likely adding materially to their exposure, and in the absence of adequate financing and debt relief, risks making the IMF a de facto lender of last resort. On the debt side, the IMF has been pressing Europe for a number of years for a more realistic policy on debt.  After all, there are well-defined policies for dealing with excessive private debt (private sector involvement, or PSI, can be a condition for Fund lending as in Ukraine recently) and for the official debt of developing countries (through the Paris Club, an informal grouping of official creditors). But European creditors, for a range of economic, legal and precedential reasons, have been deeply resistant to setting such rules in place for Greece and other heavily indebted periphery countries (although granting substantial relief on an ad hoc basis). The Greek crisis now has made the debate urgent, and U.S. Treasury Secretary Jack Lew in meeting with European leaders today will lend his support to this position (though U.S. leverage on the issue appears limited).  Actual cuts to principal appear unlikely, though long-term grace periods seem achievable. If indeed debt relief falls short of the Fund’s target, I would still expect there to be a program. That might require the Fund to adopt an optimistic (if unrealistic) assessment that the program has a high chance of success, as was done for the 2014 Ukraine program.  Alternatively, it could invoke the so-called systemic exception, a 2010 rule devised originally for Greece that would allow it to waive the debt sustainability test. The IMF would be loath to use this rule, in part because it does not see this crisis as necessarily systemic, but some of the major creditor countries may see this as a realistic acknowledgment of the geopolitical importance of  the effort to keep Greece in the eurozone. A better way to look at the IMF’s analysis (and their unusual decision to release the documents) is that battles among official creditors are becoming an increasingly common feature of the a rapidly growing international financial system. Consequently, the needs of countries in crisis are growing faster than the resources of the Fund (creating large financing gaps), and swings in capital flows can leave sovereigns with high levels of debt. From this perspective, the failure of Congress to pass IMF quota reform, and broader constraints on increasing quotas, leads to an inherent tension for the Fund, whose rules were drawn up in simpler times.  Greece represents an important, but by no means unique, test of their capacity to adapt.

European leaders, meeting tonight in Brussels, appear to have given Greece something close to a take-it-or-leave-it offer.  If the Greek government can pass far-reaching reforms by Wednesday, creditors will provide bridge financing to meet near-term debt payments and cash to reopen the banks.  These steps also would allow a rebuilding of trust and allow negotiations on a third bailout that could total €86 billion to proceed. It is unclear as of now whether the Greek government will take this deal, or end negotiations knowing that a failure tonight could signal Greece’s exit from the eurozone. Even if Prime Minister Tsipras does agree to these measures, the risk of failure is high, and deteriorating economic and financial conditions will further stress the government.  Already there are reports of significant fissures within the ruling Syriza party, which could result in a political realignment (and possibly an unaffordable delay) if the government is forced to rely on substantial opposition support to pass these measures. At this stage, it is hard to have much confidence that this route will lead to a Greece that is competitive and growing sustainably within the eurozone. What creditors are offering The proposal, as reported by various news agencies, requires the Greek government to pass a broad range of reforms by Wednesday, July 15. These include: substantial VAT and pension reforms; a new code of civil procedure as part of judicial overhaul; full implementation of past EU laws, including procedures for automatic fiscal cuts when targets are not met; and, implementation of bank recovery and resolution directive as first step towards fixing the banks. Many of these proposals had been floated in earlier rounds of negotiations, but the requirement that they all be passed by Wednesday is daunting. Conditional on above, negotiations will be launched on a third bailout package and would include further reforms including: (i) Eliminating the pension deficit (that now stands at 10 percent of GDP); (ii) Adoption of ambitious product market reforms; (iii) Privatization of the electricity transmission network (ADMIE); (iv) A comprehensive labor market review including collective bargaining, industrial action and collective dismissals and a commitment to European best practice; (v) Large-scale privatization, including the possibility that €50 billion of assets would be turned over to an EU-controlled facility; and (vi) Broad-based administrative reform. The financing program would be between €82 and €86 billion. Most of the funding would come from the European rescue facility (ESM), but IMF monitoring and financing is a precondition for a new ESM arrangement. Financial support would include a near-term bridge of around €7 billion by July 20 and another €5 billion by mid-August that would allow it to meet upcoming debt payments and clear arrears with the IMF, but fiscal support for the reactivation of the economy would appear to wait for the approval of the larger program later this summer. I assume that a possibly significant expansion of emergency liquidity (ELA) by the ECB would be part of the package. There is no explicit commitment to debt relief in the proposal, meeting German concerns about setting new precedent but denying Greece political cover that they had sought for the reform package. Longer grace and repayment periods would be considered conditional on full implementation of measures and after a positive first review of a new program, so around end year. Finally, there has been discussion that Greece would take a "time out" from the eurozone if a deal can’t be agreed, with the promise of a return at some future date.  This is clearly provocative and probably not essential to a deal. Ambitious but likely to fail This is an extraordinary ambitious package, and includes an intrusive continuing role for the Troika (IMF, ECB, and EU). Further, as difficult as passage of the July 15th measures will be, the requirements for a third bailout looks to be an even more substantial ask of the Greek government, which raises the prospect that the stage one agreement is a bridge to another confrontation and crisis. As I mentioned earlier today, the massive financing need is a problem.  There are hints in the document that that financing could fall short, which would then require additional fiscal adjustment or privatization measures. (Greece has already strongly objected to turning over privatization assets to a EU-controlled institution.) It also is unclear whether a buffer fund of €10-25 billion for recapitalization and resolution costs is included in the gap or additional, but in either case the banking costs are substantial and growing by the day. The IMF cannot be thrilled by the proposal. The IMF has been wary about committing financing to a package that doesn’t have debt relief, which is not explicit here, and should worry that they will be asked to pick up the residual if financing falls short. Their exposure is already high and exceptional access would be difficult to justify in these conditions under their rules.  Meanwhile, the Greeks would far prefer to not have a new IMF arrangement. Both sides look like they will be disappointed on this point. In sum, a very tough and risky choice for Greece. Negotiations are continuing, but aside from some hot button issues (e.g., privatization) and some smaller issues on the margins, there would appear to be little appetite for additional concessions from creditors.  We should learn soon which direction Greece will take.