03 July 2015

Greferendum Snapshot

As Greeks head to the polls on Sunday in a rushed and confusing referendum, their membership of the Eurozone will undoubtedly be at stake. No matter the outcome, it is hard to see a particularly stable or positive future for Greece. ‘Yes’ would involve lengthy and difficult negotiations on a new bailout, which, due to the deteriorating economic situation in Greece and the lack of trust between creditors and the government, could mean stricter terms than were on offer previously. It is hard to see the current Syriza government staying in power for long under a ‘Yes’. Therefore, snap elections could be needed soon. However, Syriza may end up winning again, bringing us back to where we started.

It is also hard to see a ‘No’ resulting in anything but Grexit, though there is a small chance Greece could live in limbo or negotiations could continue. The transition out of the euro will be painful and will require the political, legal and economic support of the rest of Europe. No matter the outcome, the situation is once again a reminder that the euro project, meant to bring Europe together, is driving it apart. The Eurozone needs to face up to its fundamental choice of whether to improve its institutional framework and tackle the flaws of the currency or reassess its membership. Living in the current limbo helps no-one, certainly not the Greeks.

What is at stake for Europe in the Greek referendum?

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Through a number of channels, Eurozone member states now have an exposure of €325bn to Greece. Official creditors in the form of Eurozone, ECB and IMF account for 76% of Greece’s public debt. This exposure has significantly increased over time, while the balance has been shifted from the private sector to the public sector via the botched bailouts and debt restructuring in 2012.

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It is obviously unlikely that all of this would be lost, but no matter the scenario it is hard not to see some of it at stake. Even if Greece stays in the Eurozone, the pressure for some kind of debt relief in the near future is likely to continue. If it exits, it is essentially up in the air.

The UK’s exposure to Greece is very limited. Its share of the IMF loans is around €1.3bn while its banking system exposure to Greece is around €9.85bn. The IMF stressed in a recent press release that, even if Greece does not repay its loans, IMF members will not see losses. The mechanism behind this was not clear, but the suggestion seems to be that any costs will be managed through the fund itself.

However, at this point in time there is much more at stake politically than economically. If Greece were to exit, it would highlight that the euro is not irreversible and that members failed to keep Greece inside even though they largely wanted to (or so they have said at least). It would also raise existential questions about the structure of the euro and EU given the sizeable blow to the concept of ‘ever closer union’.

How will the referendum work?

The polls will open at 5am BST and close at 5pm BST, with the first exit polls expected soon after. According to RANsquawk, a newswire, the targets are for 20% of the votes to be counted by 7pm BST, 50% by 9pm BST and 70% by 10pm BST. However, given the lack of preparation this may prove an optimistic timetable and results could take longer to come in. It is also worth remembering that, for the referendum to be valid, it must see at least 40% turnout (though this should be passed) but even then referenda in Greece are not legally binding on the government.

Latest polls show it is neck and neck:

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What would a ‘Yes’ vote mean?

There is huge uncertainty over what is actually being voted on, since the previous programme and the proposed extension cited in the question have expired. As such, even with a Yes, it would not be as simple as just accepting the previous offer. It would likely mean the government returning to the negotiating table with the creditors and possibly starting negotiating on a new agreement.

New agreement complicated by IMF stance: The new agreement will likely follow the proposal for an extension closely. As such, it could only run for six months. However, this position has been complicated by the now published IMF Debt Sustainability Analysis. The IMF has said that Greek debt is “unsustainable” and requires restructuring. It has also highlighted that Greece could need up to €52bn over the next three years. German Chancellor Angela Merkel has confirmed that she cannot envisage a third package without the IMF. However, for the IMF to take part in a new programme it needs to have assurances over the debt sustainability of the country and of the financing of the country for the next twelve months. While the fund has broken these rules before for Greece, it may be less willing to now given the lack of trust and patience with both Greece and Eurozone partners. As such, striking a deal could be more complex than imagined and take much longer than forecast to negotiate. For example, negotiating a new deal took a week for Ireland, a month for Portugal and Spain and the better part of a year in Cyprus. Of course, this deal will likely have to be approved by many of the Eurozone parliaments as well.

The IMF has to be included in any new aid programme for Greece, if it indeed one is concluded.

Angela Merkel, German Chancellor, 1 July 2015

In the meantime, it is hard to imagine there being much stability in Greece. Ultimately, the threat of bank runs will not recede until Greece’s place in the Eurozone is assured. This means a new programme. Therefore, some form of capital controls could still well be needed during negotiations. This will depend on the response of the ECB. It will likely approve an increase in Emergency Liquidity Assistance (ELA) for Greek banks as a deal will be on the cards again. However, how large the increase will be is unclear. It may keep the increments small to ensure there is pressure for a quick deal. Given the severe shortage of hard currency, this may also need to be provided quickly by the ECB.

On the point of trust, it is clear that the other Eurozone governments do not trust the Greek government any longer and they certainly wouldn’t trust it to implement a ‘Yes’ vote properly after it campaigned for a ‘No’ vote. As such, any new programme could come with even stricter implementation, oversight and review requirements. So, after everything, we would likely be back at the same negotiating table having the same negotiations. It would also not be surprising if the Greek government, when offered an amended deal, accused the creditors of moving the goal posts despite the fact that they have made it clear that the deal will expire before the referendum.

New elections could be needed: Furthermore, there is also a strong possibility of new elections. Given his categorical position, it is hard to imagine Alexis Tsipras continuing as Prime Minister if there is a ‘Yes’ vote. As such, he may be forced to resign with a government of national unity or a technocratic government taking over in the short term before new elections are held as soon as possible. Bank of Greece Governor Yannis Stournaras has already been touted as a potential interim technocrat Prime Minister. However, this could be tricky in purely practical terms due to the parliamentary majority (12 seats) of the current coalition government. We don’t expect them to let go of power easily. Of course, this is not a recipe for stability and would add to significant confusion – further depressing the Greek economy as people and businesses wait to see on the outcome.

Even if elections are held, there is (based on current polls) a good chance Syriza would win again and possibly with an even larger majority. So we would be in a strange situation where you have the referendum to endorse the proposal and then a fresh election mandate for a government which wanted to reject it. Where this contradiction would leave us is unclear. Whatever happens, throughout all of these negotiations and possible elections it is hard to see capital controls being lifted fully since Greece’s place in the Eurozone will not be secured. As such the economy will continue to be hit hard for some time to come

What would a No vote mean?

It is very hard to see this as anything but a vote for Grexit. Whatever offer is voted on or whatever is seen to be voted on, there is no doubt that this is a ‘take it or leave it’ offer. It seems very unlikely that in the event of a ‘No’ vote the creditors would produce a different offer. If they did it would surely be a significant dent to credibility.

The exact process towards Grexit is far from clear (see here for more detailed thoughts). However, in the event of a ‘No’ vote, the ECB would likely have to cut off the ELA to Greek banks. This could be done a number of ways either by significantly capping the level available (down to €500m) or by significantly increasing the collateral needed to borrow under ELA. This would eventually precipitate the need for Greece to begin printing/creating its own currency to help fund Greek banks and avert a financial collapse. Theoretically, Greece could live in a limbo inside the euro with capital controls in place and some kind of parallel currency circulating. But the question we have to ask is: why?

In the end, living in such limbo would be incredibly painful for the Greek economy. Furthermore, it would mean doing so without a clear end game in sight. Unless this situation is simply buying time for a new government to come into place and resume some kind of bailout with the creditors then there seems to be little benefit. As such, a ‘No’ vote would probably precipitate a Grexit.

We also believe it is likely and possible that Greece exits the Eurozone but stays within the EU. This would be to the advantage of all involved to minimise the economic pain for Greece and to maintain geopolitical and social stability in the country. However, a Grexit would probably require changes to the EU treaties to ensure legal certainty for the new Greek currency, to allow for a clear devaluation and to allow Greece to set up the necessary economic institutions (such as a central bank) outside the Eurosystem. As we suggested back in 2012, this could be done using the ‘flexibility clause’ (Article 352) in the EU treaties in the short term with a full treaty change used in the medium to longer term to clear up the number of uncertainties the event would raise.

On top of this, it is likely that Greece would need technical expertise to aid its transition but also financial aid. The banks would have to be restructured and recapitalised, which the government cannot afford to do and there is little in terms of liabilities to bail-in. The newly separate Bank of Greece would need assistance from the ECB and IMF to help manage its new currency, not least because it may not have significant foreign exchange reserves.

Open Europe’s expectation

Despite the polls being neck and neck, we believe a ‘Yes’ vote looks more likely but only just. The impact of capital controls will have been felt hard by Sunday especially with pensioners now unable to access their funds – a group which Syriza has sworn to protect. This is then likely to lead to negotiations on a new package. Ultimately, Syriza is correct that this will be a repeat of the ‘extend and pretend’ approach and we could well find ourselves back in the same position in a few months. There is no doubt that Greece will need further debt relief eventually. But with 76% of Greek public debt owned by official taxpayer backed institutions, this is an inherently political discussion.

All this drives home that the EU and the Eurozone need to face up to internal flaws sooner rather than later. For five years now the Eurozone has been dancing around the fundamental question of whether it can integrate more deeply or whether it should reassess its membership. Living in this limbo where countries give up their economic sovereignty and policy tools in exchange for the minimum lifeline to keep them afloat is not sustainable and is driving countries in Europe apart rather than together. If the only reason not to ask these questions is because they are afraid of what people might say, then that is no reason at all. No matter the outcome on Sunday, Europe should heed the warnings from Greece which it has previously ignored and face up to what type of union it wants to be and needs to be to work better for all involved.

Background reading