Europe’s turn to say “Oxi”

By Meagan Greene

After the referendum, a Greek deal may not be impossible but is unlikely.

ATHENS — Greeks surprised everyone last Sunday by decisively voting No in the country’s referendum. The mood in Athens’ central Syntagma Square was one of defiance, with people celebrating and dancing as the results came out putting the No vote ahead with just over 60 percent support. The risk of a Grexit has increased materially with this referendum result, but it is not yet a foregone conclusion.
What the referendum means
Prime Minister Alexis Tsipras promised Greeks that if they voted No in the referendum, Greece would have a stronger negotiating position with its creditors. This is unlikely to be the case. Many Greeks thought that a No vote meant no more austerity. In reality, any new deal will involve more austerity than the deal Greeks rejected on Sunday, given that capital controls will have pushed the economy even further into recession. It is unclear whether Tsipras will be able to sell more austerity to his party and to the Greek people.
His chances of doing so are greater now in the wake of Sunday’s referendum. The referendum result, at least in the short term, has served to silence the opposition. The leader of New Democracy, Greece’s largest opposition party, resigned as it became clear that the side that he had backed — the Yes camp — had lost so decisively. Tsipras has never been stronger, and if creditors hoped to be dealing with a different Greek prime minister after Sunday’s vote, they now realize Tsipras is the only option in Greece for now. Now backed by a larger part of society, Tsipras has more momentum behind him to agree to unpopular measures.
Even if Greece agrees to these measures, the chances of implementation are slim. This point is not lost on Greece’s creditors. From their perspective, an “untrustworthy” negotiating partner — the Greek government — now has the backing of the Greek people to resist the eurozone’s bailout architecture, which involves financing in exchange for strict conditionality. The creditors already lacked confidence that Tsipras could implement a deal. That confidence will have been eroded even further by the referendum outcome. What’s more, Greece’s creditors no longer fear the fallout of a Grexit the way they did last time Greece was on the precipice, in 2012. Wrongly, in my view, they believe that the rest of the eurozone has been ring-fenced from Greece thanks to the banking union and the ECB’s QE program.
A deal is unlikely, but could still happen
Given their respective positions, a deal between Greece and its creditors looks unlikely. It would require two main concessions. First, Tsipras would have to be able to sell a huge fiscal adjustment to his own government and people — quite a turnaround from what he has been promising over the past week. In order to do this, he would need a carrot from the creditors.
One of Tsipras’ key demands has been for debt relief to be part of a deal with the creditors. This could serve as the carrot that Tsipras needs to sell a deal as a victory at home. The IMF came out last week with an official debt sustainability analysis highlighting that Greece needs debt relief. The IMF has held this position for years, but has only formally acknowledged it at the institutional level (as opposed to statements by various IMF officials) last week.
Despite overwhelming evidence that Greece’s debt burden is unsustainable, Greece’s creditors are unlikely to sign up for debt relief as part of a deal. Germany in particular has been open to debt relief for Greece in principle, but wants to see a track record of policy implementation before promising any net present value reduction of Greece’s debt burden.
Still, debt relief must be on the table for there to be a deal, and it is not impossible that Germany could agree to this. There is a deep schism between senior members of the German government on the issue of debt relief: Chancellor Merkel would be willing to consider it, but the ministers of finance and economy — Schäuble and Gabriel, respectively — are dead-set against it. So far in this crisis, Chancellor Merkel has managed to get her way. It would require political courage for her to overrule senior ministers in her government and risk losing more support among MPs in her party when she is almost certainly seeking yet another term in power.
The banks determine the timing
There have been many false deadlines in the Greek crisis this year, but Greece is about to hit a few hard deadlines for agreeing on a deal this month. Greek banks had roughly €1 billion in cash reserves as of last Friday, and Greeks have been withdrawing an average of €300 million per day. Last week, Greece had an unusual hybrid of a bank holiday and credit controls, which meant no businesses could deposit cash back into Greek banks. This will likely change again this week with the imposition of full capital controls. With businesses depositing some of their cash, Greek banks will have a few more days before they run out of money. It is likely that the Greek government will reduce the maximum withdrawals for Greek deposits from €60 per day to around €20 per day. But even if deposit withdrawals are reduced, Greek banks could run out of cash next week.
The Greek economy has always been heavily reliant on cash. If Greeks are unable to withdraw any of their deposits from machines, there could be social unrest. Capital controls will make it difficult for Greek businesses to import goods as well, and the effects will likely be felt immediately in grocery stores and at petrol stations.
This liquidity crunch can only be alleviated in the immediate term by the ECB, via an increase in Emergency Liquidity Assistance (ELA) to Greek banks. In the absence of a deal — or at least concrete progress towards a deal — it is unlikely the ECB will increase its own exposure to Greece. By raising ELA to Greek banks, the ECB would effectively be financing a bank run. ECB will likely avoid ratcheting up pressure on Greek banks in the next few days to give policymakers some chance of coming to an agreement on a third bailout for Greece. But this is probably the most we can expect from the ECB.
Beyond the immediate liquidity crunch Greek banks and people are facing, there is hard deadline for getting a deal by July 20, when the government owes €3.5 billion to the ECB. If the Greek government defaults on this payment, the ECB will likely move swiftly and recall the €89 billion in ELA already provided to Greek banks.
Greek banks cannot afford to return this liquidity, so the ECB would probably deem them insolvent and demand resolution or recapitalization plans for Greek banks. The banks may undergo bail-ins, with citizens forced to accept a haircut on their deposits — even those under the €100,000 deposit guarantee. The Greek government could also choose to print a new legal tender to bail out the banks, redenominating everyone’s deposits into this new currency.
Grexit risk higher
The unexpected, decisive victory for the No camp in Greece’s referendum is likely to embolden the Greek government in negotiations, but will do little to change the creditors’ position. The result is likely to be protracted negotiations at a time when Greece is facing immediate hard deadlines due to the state of its banks. If a deal is struck, there is a chance it will not be implementable and we will find policymakers back in Brussels for emergency negotiations once again. If a deal between Greece and its creditors cannot be struck within weeks, a Grexit is extremely likely.
The markets have had only a muted response to recent developments in Greece so far. This is short-sighted, in my view. The immediate impact of a Grexit will be a slightly weaker euro and disappointing equity market performances in the eurozone. But the long-term impact could be huge. Once a precedent for a eurozone exit is established, bigger countries such as Spain and, especially, Italy will be sorely tempted to abandon the currency peg and benefit from a nominal devaluation next time they see growth falter. This could severely undermine the common currency.