Greece: Austerity, Relief or Exit?

9:26 AM EST JAN 23, 2015

By Marcus Walker

The Wall Street Journal

Greece’s elections on Sunday take place against the background of rising tensions between the small nation and its main creditors, eurozone governments and the IMF, about the country’s strict bailout regimen. Polls point to a win for leftwing opposition party Syriza over the ruling conservatives of New Democracy. Would a Syriza-led government start a game of chicken with Germany and other creditors that could lead to havoc and a Greek exit from the euro? Or can a compromise be found? Here’s our crystal ball.

Q: Who will lead the next Greek government?

Very likely Syriza (whose leader, Alexis Tsipras is pictured above), the leftwing opposition party, unless the conservative incumbent, Premier Antonis Samaras, pulls off the biggest upset victory since Harry Truman in 1948. Syriza might win an absolute majority in Parliament, but polls suggest it will fall just short, requiring support from another party. A pact with centrist To Potami (The River) or center-left Pasok could make the government more pragmatic in talks with Greece’s international creditors. A pact with the nationalist Independent Greeks could make it more hardline.

Q: What agreements with creditors would Syriza need to reach to keep Greece afloat?

Syriza, eurozone governments, and the International Monetary Fund would have to agree on an extension of Greece’s bailout program that does several things:

- Reassures creditors that Greece will continue to improve its budget balance and overhaul its economy;

- Promises fiscal and reform measures quickly that unlock delayed bailout aid worth €7.2 billion ($8.1 billion); and

- Keeps the European Central Bank confident that Greece will stay in the euro, so that the ECB allows Greek banks continued access to central-bank liquidity, even if there are heavy deposit outflows.

Q: How much time is there to avoid a Greek debt default or banking crisis?

The latest deadline for a deal with Europe is July/August, by when Greece needs billions in new financing to repay bonds held by the ECB. But eurozone officials fear Greece could run out of cash as early as March, when repayments of IMF loans fall due. And if talks between Athens and creditors go badly, capital flight—especially deposit outflows—could happen even earlier.

“They don’t have time,” says Gabriel Sterne, head of global research at consultancy Oxford Economics. “Events could become compressed. Someone has to blink quickly.”

Q:Why would Syriza sign up to austerity measures and economic overhauls that it expressly rejects?

To avoid panicky deposit withdrawals and a renewed economic crash. Syriza officials say they could accept a deal on fiscal discipline that would allow Greece to run a primary budget surplus (excluding interest) of 2% of GDP, instead of Greece’s current 4.5% target. That would require European governments to relieve some of Greece’s debt, by reducing the interest rate and extending the maturities on bailout loans.

Q:Why would Europe agree to that kind of soft debt relief?

It has done so before, when recalibrating Greece’s progam after it went badly off track amid similar political uncertainty in 2012. A recalibration of the bailout program—its targets, its timetables, and the financing terms—is almost inevitable now because this winter’s political drama has knocked Greece’s economy and budget off track. But Syriza would still have to perform a major U-turn on its fiscal promises in order to credibly achieve even a 2% primary surplus. It will be hard for Syriza, but it’s been done before. Mr. Samaras did a U-turn on austerity when he won election in 2012.

Q:What about the structural reforms that are part of the bailout terms?

That could be even more difficult for Syriza than a U-turn on fiscal policy. All of Syriza’s ideological tendencies reject the market-oriented overhauls, privatizations, and deregulation measures that Germany and other creditors say are essential for restoring Greece’s economic competitiveness. Syriza wants to reverse some of the reforms already enacted. Creditors say Greece has to take such overhauls further. The gap between the two positions is huge.

Q:If a compromise can be found – enough reforms, enough austerity, enough debt relief – will Greece be saved?

Not necessarily. Since 2010, keeping the bailout program on track has proved even harder than agreeing its terms. The current program relies on optimistic growth and fiscal forecasts. And Syriza has yet to prove it can run a government and implement difficult overhauls. If the program goes off track again, creditors will demand extra austerity and reforms, which could push a Syriza government to breaking point—as happened to the Samaras government this winter. If Syriza cracks under the pressure, another round of uncertainty and early elections will follow, perhaps returning conservative New Democracy to power.

Q:What if no agreement can be reached?

That’s a serious risk, given the chasm between Syriza and creditors, especially Berlin. Even rising doubts about whether a compromise can be found could lead to heavy deposit withdrawals from Greek banks and capital flight from the country. At that point, the ECB would have to decide whether to keep liquidity open for Greek banks or to cut them off, because of the lack of a prospective agreement and Europe’s rising financial exposure in case Greece leaves the euro. Greece and the eurozone would very likely have to impose capital controls, like in Cyprus, to stop the capital flight. But that would probably be an interim step. Either Syriza would have to give in and sign a bailout program, or Greece would have to print drachmas to keep the economy, government and financial system from collapse.

Q:Is Germany prepared to countenance Greek exit from the euro?

Chancellor Angel Merkel would certainly like to avoid a Grexit. The media coverage of a financial meltdown and economic devastation in Greece that would follow Grexit would likely be deeply damaging for Germany’s standing in Europe. Moreover, Germany, like other eurozone countries, would face heavy losses on bailout loans and central-bank exposure to Greece.

But Germany can only continue to finance Greece if there’s a counterparty: a government in Athens that is prepared to run a significant primary budget surplus, and to overhaul the Greek economy to make it more viable inside the euro.

Q:And if Syriza refuses to meet those terms: Will Merkel blink?

No. German leaders fear that funding a Greece that refuses to reform would be the death knell of the eurozone. Other debtor countries could conclude that they could blackmail Berlin, refuse to cut their deficits or overhaul their economies, and still get German taxpayers’ money. The cost of lending to a recalcitrant Greece would eventually reach far higher than the cost of Grexit, German politicians are convinced. If Syriza doesn’t blink, then Ms. Merkel could reluctantly say auf Wiedersehen, Griechenland.

Q:Will Syriza blink?

Possibly, if failure to come to terms quickly with Europe leads to deposit flight and Grexit panic, battering Greece’s economy. Syriza might also split and fall from power in such a situation, triggering another election. The big question is whether Syriza will overplay its hand, realizing the weakness of Greece’s position only too late, when bank deposits are already fleeing the country.

http://blogs.wsj.com/briefly/2015/01/23/greece-austerity-relief-or-exit-the-short-answer/