The biggest problem facing the Eurozone may be too late to avoid: a Greek exit from the Euro. While both sides are unprepared and unwilling to accept this worst-case scenario, hope still remains for a political deal.
Greece and its creditors have less than three weeks to decide whether Athens will remain in the Eurozone. Athens has to pay out more than 1.7 billion euros in pensions and salaries at the end of April, and make a 186 million euro repayment to the IMF by May 6.
The Greek state’s only option, despite public denials, will be to raid the remaining cash reserves of public bodies such as local councils and social security funds. The current government has already used such funds through repo transactions, and it passed a legislative act effectively sanctioning this approach on April 20.
After that, there is no indication the Tsipras government will have enough money to pay the IMF 707 million euros on May 12, as well as honor outstanding salaries and pensions. Consequently, the crucial date in the negotiations will likely be the Eurozone finance ministers meeting in Brussels on May 11.
Is the EU willing to let Greece default and exit the Eurozone?
Although this is obviously not an easy question to answer, the period until February 20, when Greece signed an extension of a previous loan agreement, offers a framework for understanding how events might unfold.
The strategy followed by Greece until a few days before the signing of the February 20 deal was to make a series of concessions before passing the ball to the other side. The German government and the European Commission responded to this by retreating and accepting the Greek position, agreeing to use the February 20 deal as a starting point for negotiations.
Greece’s creditors, on the other hand, delayed any final deal in order to raise their bargaining leverage by simply demanding concessions at the last minute. This scenario is likely to repeat itself because, firstly, the creditor side does not want Greece to default and exit the Euro and, secondly, they are already using this strategy.
Greece may default without ushering in a Grexit
One option is that Greece could default without leaving the Euro. The problem with this option, as Wolfgang Munchau pointed out, is that neither side is actually prepared for it. The EU has overestimated its own strength and is not thus prepared for such a possibility. The Greeks on their part cannot design the necessary logistical planning within the current time constraints.
Taken in conjunction with the fact that the Greek government is not prepared to abandon its red lines, the current situation seems even more worrying. Greek premier Alexis Tsipras is facing pressures from his own far left MP’s not to abandon the party’s electoral pledges. They have proved this by taking a series of initiatives without his approval, such as the parliamentary bill pertaining to Greece’s so-called ‘’humanitarian crisis’’.
The most likely scenario is for the Eurogroup to provide new bailout funds, namely the 1.9 billion euro bond profits that Greece is targeting, in return for some non-controversial reforms, such as a legally enshrined tax authority.
On the other hand, one might argue that German Chancellor Angela Merkel will not concede unless the Greeks implement some concrete reforms. This factor should not be overestimated, however. The German chancellor has in the past managed to pass through parliament a series of unpopular bailouts following her warnings on the risks of non-action.
Yet, if the EU does not behave according to the strictures of this assessment, then some form of parallel currency and a referendum on austerity are highly likely.
Investors should watch closely for a political deal
The uncertainty surrounding Greece’s financial position led to a sell-off in financial stocks in European equities indices. A few key elements of the sell-off are particularly noteworthy.
Firstly, the sell-off is led by German banks, and there were bigger declines in the periphery of the Eurozone. Spain’s IBEX 35 fell 2.2% and the PSI 20 in Portugal dropped 2.3%.
Second, Greek Government bonds maturing in 2017 skyrocketed 79 basis points to 26.81% and ripples were felt on yields of Spanish, Italian and Portuguese government bonds. By contrast, yields on 10-year German Government bonds dropped to a record 0.05%.
Consequently, we are witnessing a situation similar to the one before Mario Draghi’s famous June 2012 announcement to do ‘’whatever it takes’’ to save the Euro: a flight of liquidity from peripheral European bond markets to core European bond markets. With such a flight in progress, a political deal could be the only remaining hope for stability in the Eurozone.
