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Pyrrhic Victory Over Greek Monster

23/04/2015 11:08 BST | Updated 22/06/2015 10:59 BST

It's politics, stupid

Without a deal between Athens and Brussels and the IMF on economic reforms and repayments of loans within the next couple of months a Grexit or Graccident would be the most extreme outcome. We cannot rule out that the parties will fail to find a solution seeing as how the Greeks are dawdling and in the light of the harsh words uttered by, among others, Germany.

However, there is still a higher chance that a compromise will be reached, albeit following tortuous negotiations. Precisely because it is not really an economic or technical decision to keep Greece on board - it's all about politics. After all, Europe does have the money. Helping the Greeks will require 'merely' dozens of billions of euros in addition to current €240bn package. The big problem will be how the politicians could 'sell' such a large-scale bailout to their voters and limit the electoral damage. The credibility of major institutions such as the IMF and the ECB is also at stake.

Clearly, the rules governing European politics and economics are not carved in stone. Whenever it suits the politicians, they will not hesitate to bend, distort, and interpret regulations and procedures as they see fit (like they did with creating the ESM/EFSF). They could do so now. And there are more reasons why a follow-up bailout for Greece is the most likely option.

Tsipras the Pragmatist or Tsipras the Terrible?

Undoubtedly, Greek PM Tsipras has exasperated his European colleges. Among others, he has set up commissions to demand German reparations for damage inflicted in WO II, and blamed previous governments for the severity of the crisis. In other ways, however, the Prime Minister takes a flexible and pragmatic approach. For instance, he has placated the largest opposition party by backing their presidential candidate and nurtured close ties with the influential Orthodox Church - even though he is an outspoken atheist - and with the army. According to Tony Barber of the Financial Times, these actions could imply that Tsipras is trying to prepare for a soft landing when he exits the euro. By contrast, we believe there is a higher chance that he is slowly preparing the country for a controversial deal with Europe and the IMF.

Grexit followed by Cyprit?

European politicians and the ECB have put on a brave front by announcing that the Eurozone is well able to cope with a Grexit. The ECB alone has a Greek exposure of €110bn and the official creditors will probably get less of their money back if they kick the Greeks out of the euro area than if they come to an arrangement.

Many analysts assume that the Eurozone can easily survive a Greek departure and that a domino effect is out of the question. The markets seem to agree - witness the relatively low bond yields in countries such as Spain and Italy. But what if the Cypriots - whose economy is closely linked to the Greek economy - say goodbye to the euro as well? The island may comprise a marginal part of the Eurozone but if two out of the 19 member states throw the towel in the ring, the irreversibility of the euro is no longer a given and borrowing costs in the southern euro states could soar.

Geopolitics cannot be ignored

In geopolitical terms, Greece is more important than one might think at first glance. It takes up a key position between East and West and is a 'portal' to Europe. Tsipras has recently flirted with the Russians when paying a visit to Moscow; even if he did not obtain financial aid. On top of this, Athens is one of the weakest links when it comes to the implementation of the sanctions against Russia on the back of the Ukraine crisis.

Just last week, the Greeks conferred with Hungary, Macedonia, Serbia, and Turkey about plans for a gas pipeline from Russia via Turkey to Greece as an alternative for the South Stream project that was recently cancelled (although some say it has not been definitely buried). Such a scheme could scupper the recently reanimated initiative to set up an EU-wide energy union. In addition, it would mean that Greece is veering towards Moscow (whereas the main aim of the energy union would be to make Europe less reliant on Russia).

Militarily, the Greeks are also making eyes at Russia as they negotiate about the purchase of s-300 missiles. From some angles, this is not just a crazy idea. The Greeks are already in possession of the associated air-defence systems. In view of the Greek debt crisis and the sanctions against Russia, it would be a strange manoeuvre but it could be shrewd. After all, European politicians will be eager to counter this military, energy and political rapprochement between Athens and Moscow - even if it costs them.

China, too, has a big finger in the Greek pie including a stake in the Port of Piraeus. This is especially relevant because the Russians and the Chinese are increasingly aiming for a strategic 'marriage of convenience' in the context of their geopolitical rivalry with the West.

The Greek monster

The Greek Finance Minister claimed that the Troika's austerity regime has brought forth a "monster of a crisis", but Europe can still succeed in bringing the monster to its knees with the help of backroom politics, ECB bazookas, and political arm wrestling. The downside is that this "pyrrhic victory" could create widespread volatility, prompting more investors to flee into German government bonds and other supposedly safe securities. This would not automatically weaken the euro. In any case, the data for the Eurozone as a whole continues to exceed expectations whereas the recent US figures have been a disappointment. And there is the possibility that the markets will view a Grexit in a positive light as the departure of the weakest link would strengthen the 18 remaining parts of the chain.