2013-06-18T00:56:10-04:00 Martin Koehring http://www.huffingtonpost.co.uk/author/index.php?author=martin-koehring Copyright 2008, HuffingtonPost.com, Inc. HuffingtonPost Blogger Feed for Martin Koehring Good old fashioned elbow grease. tag:www.huffingtonpost.com,2013:/theblog//3.2741013 2013-02-22T09:08:13-05:00 2013-04-24T05:12:01-04:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
According to data from the Bank of Greece (the central bank), the improvement in the current-account balance in 2012 was primarily driven by a sharp narrowing of the merchandise trade and income deficits. These were partly offset by a modest rise in the surplus on the services account and a sharp increase in the current transfers surplus.

Imports collapsing, interest payments down sharply
Merchandise exports (excluding volatile items such as oil and ships) rose by a moderate 3.8%, but imports continued their collapse and were down by 15%. The export/import ratio of 1:1.6 in 2012 has contracted significantly since 2010, when it stood at 1:2.4. Meanwhile, the income deficit, which consists of interest, dividends and profits, also narrowed drastically in 2012 as a consequence of significantly lower interest payments following the write-down of more than 50% of the face value of Greek government bonds (GGBs) held by the private sector in March 2012 (so-called private-sector involvement, or PSI) and deferred interest payments on support-mechanism loans from the European Central Bank (ECB).

On the services account, net travel earnings (primarily from tourism) were down fractionally. Arrivals fell by 5.5% in 2012 and non-resident spending in the country decreased by 4.6%. But travel spending abroad by Greeks dropped even more sharply, by 18.4%. Meanwhile, net transport earnings (largely from shipping) recorded a modest increase. Again, while receipts were down by 5.7%, payments were down by an even higher rate of 12.6%. Meanwhile, the current transfers balance showed a net improvement largely as a consequence of increased transfers from EU structural funds.

Why is external rebalancing important?
The rebalancing is significant because it helps to reduce Greece's external debt (including private and public external debt). External debt still stood at a staggering 214% of GDP in the third quarter of 2012. Although the Greek debt crisis has been primarily about the unsustainable size of the government's debt (sovereign debt), the whole economy (including households and firms) has depended on external financing to fund high levels of imports as a result of a surge in domestic demand prior to the debt crisis. This dependence on external financing by peripheral countries such as Greece, combined with euro zone-wide financial interdependence, lies at the heart of the euro zone debt crisis. As external rebalancing continues, Greece's dependence on external financing lessens and the country's economic agents can focus on reducing their debt.

Stronger focus on export expansion?
So far, the rebalancing effort has focused on import contraction, and also benefited from lower interest payments in 2012. However, the concomitant collapse in domestic demand and GDP is unsustainable, brought about by horizontal cuts in wages and pensions as a consequence of the government's fiscal austerity agenda, which, in turn, is supervised by the country's EU/IMF creditors. The social and political consequences of austerity are reflected in a rapid fall in ordinary Greeks' standard of living, rising unemployment and growing risks to political stability and social peace.

A more sustainable path to economic recovery would be the expansion of exports of goods and services. But these have remained relatively sluggish. The structural reforms in the Memorandum of Understanding (MoU) agreed with the EU/IMF stress labour market measures to improve competitiveness in the hope that Greece can export its way out of its slump. Key measures include a steep reduction in the minimum wage, greater leeway for company-level labour agreements, a reduction in severance payments and more flexibility on working time. The reforms have already led to a substantial improvement in export competitiveness via lower inflation and labour costs.

However, "internal devaluation" alone is also unsustainable in the long term if economic recovery (which would revitalise suppressed household disposable incomes) fails to materialise. Hence, the EU/IMF lenders have also emphasised measures to boost productivity and open product markets. Moreover, other measures are supposed to improve the transport of Greek goods, including liberalisation of road haulage and privatisation of the railway system.

However, export recovery depends not only on developments in Greece itself, but also on prospects for the euro zone as a whole; around 60% of Greek exports go to fellow members of the currency area. We expect another economic contraction in the euro area in 2013, which will dampen Greece's export performance this year. Moreover, the resurgence of the euro since late July 2012 (which has made Greek exports outside the euro zone more expensive) weakens prospects for exports to non-euro area countries.

Another stumbling block to an export boom is the credit crunch, which means that exporters now face a lack of operating capital. A survey published in late 2012 by the Panhellenic Exporters Association (PSE) showed that 38.7% of export companies sampled faced severe liquidity problems and difficulty in gaining access to credit. This compared with 25.2% in 2011 and just 7.3% in 2010.

Further rebalancing ahead
Although the pace of the rebalancing is set to moderate as the effects of PSI on the income account fade, we expect further improvements in the current account over the coming months and years. First, the income account will still benefit from lower interest payments during 2013 thanks to another reduction (by around one-third) in the face value of GGBs held by the private sector in the wake of the government's debt buyback in late 2012. Second, we expect the collapse of imports to continue at least until 2014 as domestic demand contracts again amid further fiscal austerity measures implemented by the government (such as across-the-board income tax hikes). And third, we expect exports to continue to grow moderately (in line with the gradual improvement in competitiveness). In particular, the prospects for the important tourism sector--which contributes around 16% of GDP and provides around 18% of jobs--are improving as there is now less uncertainty about Greece remaining in the euro zone following the resumption of EU/IMF lending since late 2012. Indeed, according to press reports in early 2013, the general secretary for tourism, Apostolos Liaskos, predicts that tourism revenue will rise to €11bn in 2013 (from €10bn in 2012), with tourism bookings for 2013 reportedly up by 15-20% from last year from all markets.]]> tag:www.huffingtonpost.com,2012:/theblog//3.2204742 2012-11-28T10:56:37-05:00 2013-01-28T05:12:01-05:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
The deal's details
The deal provides significant debt relief to Greece, particularly through: lowering interest rates on concessional loans made under the bail-out programme; extending maturities on bilateral and EFSF loans by 15 years (the EFSF is the eurozone's temporary bail-out fund); and transferring to Greece profits on Greek government bonds made by the European Central Bank (ECB).

The government is expected to use the ECB profit rebate (estimated at around €11billion) to buy back at a discount (no higher than the closing price of 23 November) Greek government bonds traded in the open market and to cancel them. The buy-back could happen no later than 12 December, just before the next Eurogroup meeting on 13 December.

If all this is achieved, the Eurogroup expects aggregate debt to be stabilised at approximately 175% of GDP by 2016 (from around 177% of GDP estimated for 2012); to be reduced to 124% of GDP by 2020; and to be "substantially below" 110% of GDP by 2022.

Lending to Greece is set to resume
The agreement by Eurogroup and IMF leaders is still dependent on ratification by eurozone parliaments. It is likely to be approved, but ratification is not a foregone conclusion. On the assumption that the deal is ratified, the EU/IMF will resume concessional lending under the €240bn bail-out programme (of which €148.6bn has been disbursed so far) in the short term, including three tranches totalling €43.7bn that have been suspended since June. By December 13th, €34.4bn will be released--€23.8bn in EFSF bonds for recapitalisation of Greek commercial banks and €10.6bn for budgetary financing. The €9.3bn balance of the suspended loans will be released in instalments during the first quarter of 2013. This will inject liquidity into the depressed economy, which has contracted by almost 20% since its pre-crisis peak in 2007; we expect the economy only to start growing from 2015 at the earliest.

The compromise avoids a haircut on Greek debt held by eurozone leaders in the short term. A haircut by official lenders (so-called official sector involvement or OSI) - on top of the haircut already accepted by private-sector bondholders of Greek debt in March this year (so-called private-sector involvement or PSI) - would have been politically unacceptable in many creditor countries, especially Germany, which faces a general election next September. However, the target to reduce Greek public debt to below 110% of GDP by 2022 is again so ambitious that OSI is still likely in the medium term, by 2020 at the latest but probably well before that time (albeit after the German election in 2013). The 27 November deal, if implemented successfully, exhausts most options available to reduce Greek debt other than an outright write-down of Greek government debt.

Major economic and political risks remain
In addition to delaying the official haircut on Greek debt, the new plan contains other elements that could undermine the lenders' targets. In particular, the debt buy-back plan may not succeed if private-sector bondholders of Greek debt (which already suffered a write-down of over 50% of the face value of their bonds in the PSI process) do not accept the terms of the buy-back scheme. As long as the results of the buy-back are unclear, the IMF will not decide on disbursing almost €5billion of IMF loans still outstanding to Greece in 2012.

Moreover, there is a high risk that Greece's economy will continue to contract sharply in the short term (as our forecasts show), which means that even the new targets for Greece's public debt/GDP ratio are unlikely to be met given lower-than-expected GDP; nominal GDP is the denominator in the public debt/GDP ratio, so that a lower GDP value automatically means a higher debt/GDP ratio.

Meanwhile, although the agreement buys time for the fragile three-party coalition government, it also places it under considerable political stress. Already Antonis Manitakis, the minister of administrative reform affiliated to the Democratic Left (DIMAR) - one of the two left-wing junior coalition partners in the fragile three-party coalition - has said that he will not implement agreed measures on reducing public-sector staff numbers by 27,000 by the end of next year. Moreover, Evangelos Venizelos, the leader of the Panhellenic Socialist Movement (Pasok) - the second left-wing junior coalition party - is likely to face a challenge to his leadership at a party congress to be held next February for supporting the stringent reforms. Finally, the prime minister, Antonis Samaras of the centre-right New Democracy (ND), the senior coalition party, is reportedly planning to reshuffle his cabinet as soon as lending to Greece resumes. Against this backdrop and amid the ongoing threat of major social unrest, there is a high risk of disruptive early elections by 2014 that could undermine programme implementation even further.]]> tag:www.huffingtonpost.com,2012:/theblog//3.2049676 2012-10-31T14:26:44-04:00 2012-12-31T05:12:01-05:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
'Building Bridges' towards stronger political stability

The government formation agreement comes less than seven weeks after the snap general election on September 12th. If the cabinet is formally accepted next week, this would be one of the fastest government formation processes in recent Dutch history; since 1977 it has taken on average 86 days for each of 13 cabinets to be formed. The pace at which party leaders Mark Rutte (VVD) and Diederik Samsom (PvdA) have found compromise on major divisive issues indicates that they wanted to send a message of political unity and decisiveness after ten years of political instability (with five elections) since 2002. Until recently, the Dutch political landscape had been at a risk of fragmentation, with the political centre squeezed by populist right-wing and left-wing forces. The unstable minority government that preceded the new VVD-PvdA coalition highlighted the risk of increasingly ineffective government in the Netherlands. The 2012 election, however, marked a victory for the political centre, perhaps indicating the electorate's wish for more stability.

Majority in Second Chamber, but not in First Chamber

The VVD-PvdA coalition is supported in the 150-seat Second Chamber (the lower house) by a combined 79 members of parliament (MPs). However, the new government lacks a majority in the less powerful 75-seat First Chamber (where it has a combined 30 MPs), which mainly has a revising role in relation to draft legislation and is elected by representatives of the Netherlands' 12 provincial parliaments. The First Chamber still reflects the political preferences of 2011, when the right-wing parties held a larger share of the vote. Without a government majority in both houses, new laws and policies have a slightly lower chance of being accepted.

Policy programme focuses on ongoing fiscal consolidation

The new government's policy agenda is centred on further fiscal consolidation to bring the country's public finances in order (public debt has risen above 70% of GDP from below 50% in 2007). To that effect, the package includes a mixture of revenue-raising measures and public-spending cuts aimed at net budget savings of €16bn (US$21bn) by 2017; the measures are worth €23bn overall, but new spending of around €7bn reduces the net effect. The bulk of savings will be made through reductions in healthcare and social security spending. The policy programme entails many compromises. Perhaps most important is the VVD's agreement to a gradual reduction in mortgage tax relief, while the PvdA agreed to cut the top marginal tax rate.

Continuity also on immigration and Europe

During the election campaign, both the VVD and PvdA had to adopt a slightly tougher line than previously on immigration and Europe in order to fend off their respective challengers from the far right (the Party for Freedom, PVV) and far left (the Socialist Party, SP) of the political spectrum. The strong presence of these two challengers in parliament (even though both underperformed at the September election) means that the new government will maintain the previous government's tough line on immigration and integration. Among other things, the new coalition plans to extend the residency period before immigrants can become Dutch citizens from five to seven years. Immigrants will not be allowed to claim welfare benefits for seven years after arriving, and proficiency in the Dutch language will become a condition for receiving basic welfare payments.

On Europe, the continuing focus on fiscal consolidation domestically means that the Netherlands is likely to remain a key ally of Germany in prioritising fiscal austerity in the highly indebted peripheral eurozone countries as a precondition for further financial support. The coalition agreement also stresses the Netherlands' support for the gradual establishment of a European banking union. Moreover, although the ministerial line-up has not been officially confirmed, the traditionally pro-EU PvdA is set to obtain the key portfolios in the new cabinet (to be led by Mr Rutte as prime minister) that deal with the euro zone crisis, namely foreign affairs (Frans Timmermans) and finance (Jeroen Dijsselbloem). In particular, the replacement of the outgoing finance minister, Jan Kees de Jager (Christian Democratic Appeal, CDA), who has been opposed to debt mutualisation and stronger federal fiscal competence in the eurozone, may mark a shift in rhetoric (although probably less in policy) under the new government.]]> tag:www.huffingtonpost.com,2012:/theblog//3.1892710 2012-09-18T06:15:58-04:00 2012-11-18T05:12:02-05:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
With around 96% of votes counted, the VVD was on course to win 26.5% of the vote, giving the party 41 seats in the 150-seat Second Chamber (lower house of parliament). This was the VVD's best-ever election result, topping the 31 seats gained at the 2010 election, which had made party leader Mark Rutte the first ever VVD prime minister. Voters thus rewarded the VVD's focus on budgetary discipline and business-friendly structural reforms. Moreover, the generally pro-European VVD had toughened its rhetoric on highly indebted euro zone countries such as Greece. This may have helped the VVD to attract Eurosceptic voters that had previously backed the populist PVV.

By contrast, the PvdA had campaigned on a platform of less deep budget cuts in order to prevent weakening the economy and raising unemployment further. The PvdA managed to win 39 seats at the election (up from 30 in 2010). This result highlights the remarkable turnaround of the PvdA's fortunes. Only a couple of weeks ago the party was far behind its left-wing rival, the SP, as well as the VVD in opinion polls. But strong performances by its relatively young (at 41) and charismatic leader, Diederik Samsom, in high-profile TV debates with other party leaders lifted the PvdA at the expense of the more outspokenly anti-austerity (as well as Eurosceptic) SP.

Heavy defeats for far-right and far-left parties

The SP won 15 seats at the election, unchanged from 2010 and a far cry from the 33-37 seats it was on course to win only three weeks ago. Relatively subdued performances in the TV debates by the SP leader, Emile Roemer, were partly to blame for this result. The more moderate, Europhile PvdA was seen by many voters as a more credible left-leaning alternative to the right-leaning VVD than the relatively untested SP.

On the far right of the political spectrum, the PVV of populist leader Geert Wilders was the big loser of the election. Mr Wilders was punished in part for causing the snap election in the first place: his running away from the budget negotiations in late April had caused the collapse of the minority government coalition between the VVD and the centrist Christian Democrats (CDA) that had until then been supported by the PVV in parliament. Moreover, Mr Wilders wanted to turn the election into a referendum on the Netherlands' membership of the EU and euro zone. This strategy backfired badly for the Eurosceptic PVV as it lost more than a third of its seats in parliament (now 15, down from 24 in 2010).

No political fragmentation

A potentially destabilising rise in political fragmentation that was feared before the election did not occur. Eleven parties will enter the new parliament, only one more than in the current parliament (the 50Plus party that campaigns for pensioners' rights). Moreover, the smaller parties did not make major progress as the battle between the VVD and PvdA led to many voters casting their votes strategically, squeezing parties such as the GreenLeft party. The CDA also recorded major losses at the election due to its ill-fated involvement in the short-lived VVD-CDA minority government that collapsed in April 2012. The centrist Democrats 66 (D66) were one of the few winners among the smaller parties.

Centrist coalition likely

The election outcome reinforces our expectation that a centrist "grand coalition" between the VVD and PvdA will probably be formed. Such a coalition would have a narrow majority in parliament (80 out of 150 seats). But it is more likely that such a coalition would want to bring in one or two additional centrist and pro-European parties in order to boost the coalition's parliamentary majority. D66 is a candidate; a PvdA-VVD-D66 coalition (known as "Paars") ruled the Netherlands from 1994 to 2002. The CDA is another candidate, but the CDA's decline in recent elections may prompt the party to opt for the opposition benches. Both the far right (PVV) and the far left (SP) are likely to be shunned by a future coalition, which would mean that Eurosceptic and strong anti-austerity elements would dominate the parliamentary opposition, while relatively Europhile parties that favour budgetary responsibility would dominate the government.

Policy differences will have to be bridged

There is an historical precedent of successful VVD-PvdA cooperation, namely during the 1990s/early 2000s. However, the VVD and PvdA will have to bridge significant policy differences in order to make such a grand coalition work. Both parties agree on the need for bringing the public finances in order but disagree significantly on the depth and extent of budget cuts. The VVD proposes austerity measures worth more than €22bn over the next parliamentary term (until end-2016), mainly by cutting public spending on social welfare, healthcare, government and development aid. The PvdA wants to reduce the budget deficit, but not as urgently as the VVD. The PvdA's proposed austerity measures would amount to just above €15bn over the next parliamentary term.

On Europe, the VVD broadly favours German Chancellor Angela Merkel's approach to dealing with the euro zone debt crisis, with a focus on stronger European fiscal oversight, budgetary discipline and structural reforms, while the PvdA favours a less austerity-centred approach like that promoted by France's Socialist President François Hollande. But crucially, both parties are generally pro-Europe and have supported the euro zone rescue mechanisms and bail-outs for vulnerable countries. Nonetheless, given the painful austerity applied at home, the new Dutch government may be less inclined to support countries that miss their targets. Several days before the election Mr Rutte rejected the notion that Greece may get a third bail-out and instead called for stricter implementation of budget cuts and reforms in Greece. Moreover, fear among both the VVD and the PvdA of losing hard-won votes to their more Eurosceptic rivals on the right (PVV) and left (SP) respectively may also mean that tougher rhetoric on Greece and other indebted countries will be maintained, despite the generally pro-European course of such a grand coalition.]]> tag:www.huffingtonpost.com,2012:/theblog//3.1824676 2012-08-23T19:00:00-04:00 2012-10-23T05:12:11-04:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
Economic depression persists

The need for renegotiation is obvious: the Greek economy is in its fifth year of depression, with the economy contracting by almost 17% in real, seasonally adjusted terms between its pre-crisis peak in the second quarter of 2008 and its latest trough in the second quarter of 2012. The unemployment rate has climbed above 23% (and above 50% among young people). Given the deeper-than-expected depression the government now thinks that savings of €11.5bn would not even be enough, but that the cuts would have to amount to around €13.5bn (around 7% of GDP) to compensate for lower tax revenues and higher social-security costs. However, further austerity is becoming economically, socially and politically unacceptable.

Tentative diplomatic efforts

Against this backdrop, this week--around two months after the election--the Greek government is taking its first tentative steps to live up to its election campaign promise to ease the fiscal burden on the economy and its people. Mr Samaras' diplomatic efforts this week include meetings with Eurogroup president Jean Claude Juncker yesterday (Wednesday, August 22nd), German Chancellor Angela Merkel on Friday (August 24th) and French President Francois Hollande on Saturday (August 25th). Undoubtedly, the meeting with Ms Merkel is the most crucial given Greece's attempts to convince the creditor countries (with Germany the biggest among them) that Greece needs extra time to implement the tough fiscal agenda. Indeed, ahead of the meetings Mr Samaras told the German daily Bild that Greece was not asking for more money from its creditors but that it needed a bit more "breathing space" to implement the budget cuts. However, such statements risk alienating Greece's impatient EU partners even further: the Greek government itself has acknowledged that a delay of fiscal targets by two years would create a financing hole of around €20bn (probably even larger). Under current circumstances (with Greece cut off from international bond markets) this means that there would indeed be the need for another bail-out by 2014, albeit smaller than the previous two ones (€110bn in May 2010 and €130bn in March 2012); even the country's relatively successful issuance of expensive short-term Treasury bills (which recently helped to avert a cash-flow crisis) would be unable to bridge such a big financing gap.

Therefore, the government knows that its chances of convincing its international lenders, especially Germany, to extend the deadline for fiscal targets are slim, but it has to try given the domestic political scene, with the austerity-fatigued electorate expecting results on the renegotiation front and a strong anti-austerity opposition in parliament constantly attacking the government. For example, after the new government announced in July that it would focus on bringing the MoU back on track (with Greece missing more than 200 MoU targets) before asking for renegotiation, the left-wing, anti-austerity Syriza party suggested that many Greek voters' worst fears had become reality and that the three-party government was backtracking on its election promise.

Weak prospects for renegotiation

But renegotiation is extremely difficult against an increasingly sceptical international backdrop, with the bail-out-fatigued international lenders insisting that Greece should deliver results on the austerity front before any new concessions can be made. The troika of international lenders (the European Commission, the European Central Bank and the IMF) will publish a long-awaited report in September on whether Greece is in compliance with its second bail-out agreement. A negative assessment could mean further delays to Greece receiving a vital €31.2bn loan tranche, making a Greek disorderly default and eventual euro exit more likely.

Indeed, Ms Merkel and Mr Juncker have already underlined that there will be no decision on fresh aid to Greece until after the troika will have delivered its report next month. In his meeting with Mr Samaras Eurogroup chief Juncker reiterated his opposition to Greece leaving the euro zone--he is aware that a 'Grexit' could lead to a domino effect that could destroy the whole euro area. Similar sentiments have been expressed by other EU leaders in the past, notably Ms Merkel and Mr Hollande, but this does not mean that Greece's demands for leniency will be met. Facing a general election next year, Ms Merkel has to balance increasing opposition at home to further financial aid to Greece (both from within her own centre-right party and the electorate) on the one hand, with remaining committed to the euro project--which has benefited Germany's economy--on the other.

Ms Merkel's strategy remains "buying time" in the short term (without committing too much taxpayers' money to euro rescue deals), insisting on fiscal consolidation and structural reforms in indebted countries, while gradually transforming the euro area into a more robust fiscal--and eventually political--union in the long term. However, in the meantime, Greece remains trapped in a self-defeating cycle of ongoing austerity and economic depression that make it unlikely that Greece will be able to repay its debt unless there is major further debt relief from its international lenders. The survival of Mr Samaras' fragile three-party government, which consists of two left-leaning parties that are sceptical of further austerity, will therefore be severely tested in coming months. Syriza leader Alexis Tsipras, who has a much more confrontational style than Mr Samaras, is already waiting for his chance if the current government collapses.]]> tag:www.huffingtonpost.com,2012:/theblog//3.1736560 2012-08-03T19:00:00-04:00 2012-10-03T05:12:02-04:00

Martin Koehring http://www.huffingtonpost.com/martin-koehring/
Between the third quarter of 2008 and the first quarter of 2012, the economy contracted by 16%, and the Economist Intelligence Unit expects a further decline of more than 7% this year and around 2% next year. The depression reduces tax revenues and rises welfare costs, making it highly unlikely that the government will meet the tough fiscal targets set by the troika of international lenders; the troika wants Greece to reduce its public debt from above 165% of GDP at end-2011 to 120.5% by 2020. However, the fiscal austerity measures and structural reforms outlined in the Memorandums of Understanding (MoU) that accompany Greece's two bail-outs (worth a total of €240bn) have so far only led to an intensification of the depression. With no growth in the economy in sight until at least 2014, debt reduction will be virtually impossible without further debt relief.

Despite the formation of a nominally pro-MoU government, political instability prevails. The three-party coalition is fragile: the centre-right New Democracy party won the election on a platform pledging to renegotiate the MoU, while its two junior partners (the centre-left Pasok and Democratic Left) are even more reluctant to implement the MoU given the social and economic costs. The centre-left parties, in particular, are also wary of the rise of a strong left-wing, anti-austerity opposition party, Syriza, which could win a new election if the government falls. These pressures decrease the government's ability to implement the MoU and receive further bail-out funds.

The social costs of implementing the MoU are reflected in a record-high unemployment rate of 22.5%, with youth unemployment well above 50%. Moreover, with public insurers often unable to pay their bills to pharmacies, a healthcare crisis is emerging, with major shortages of prescription drugs. These factors increase the risk of destabilising social unrest that could trigger a government collapse and eventual Grexit.

Finally, Greece's relations with its EU/IMF creditors have become increasingly strained, and the new government is desperately trying to restore some confidence. But Greece is still missing more than 200 MoU targets, including reducing the public-sector payroll and privatising state assets. The patience of key stakeholders, especially the IMF and Germany, could soon run out, leading to their withdrawal from the bail-out deal.

Restoring confidence is a priority

To overcome these risks, Greece will first have to restore confidence among its international creditors. The first step in that direction appears to have been made, with the government agreeing on additional budget cuts worth €11.5bn for 2013-14 in the hope that this will lead to a more positive troika assessment of Greece's MoU progress. Greece needs to secure the next bail-out tranche of €31.2bn in September. The troika will return to Greece for a final assessment of progress in early September. A negative assessment could result in withholding bail-out funds and 'Grexit' within weeks.

Another key deadline is August 20th when Greece has to repay two bonds worth €3.2bn, mainly held by the ECB. As Greece has not received any bail-out funds in recent weeks amid the political uncertainty, the country cannot currently repay the bonds. It has three options: 1) it can sell 3-month Treasury bills (but these are costly); 2) it may try to convince the euro zone to provide bridge financing; or 3) the ECB may grant an extension for the debt redemption. We think a compromise will be found, but the episode highlights that more cash flow crises are likely to occur even if this one is overcome.

Tough negotiations ahead

Developments in Greece will remain in the spotlight in 2013-14 when the government will hope to renegotiate the MoU's targets. However, even extending fiscal targets by two years (from 2014 to 2016) may require a third bail-out worth around €20-€50bn. Amid growing 'bail-out fatigue' in Northern Europe, this will be difficult to achieve. Moreover, with debt sustainability unlikely to be achieved through the MoU and given the lack of economic growth, there is a case for debt relief by the ECB, other central banks, the bail-out funds and other public holders of Greek debt--so-called 'official sector involvement' (OSI)--in addition to March's 'private sector involvement' (PSI) that reduced Greek government debt held by the private sector by more than 50%. Although OSI is already said to be discussed by Greece's creditors, it would be politically difficult to justify, not just by EU institutions but also by governments in countries such as Germany and Finland that face growing Euroscepticism among voters.

Does all this mean that a Grexit is becoming more likely? Not necessarily, at least in the short term. At the moment, the costs of Grexit for Greece and the euro zone are still too high. For Greece, the costs (hyper-inflation, banking-sector collapse, erosion of household savings etc.) currently outweigh the benefits (improved competitiveness, lower debt). Likewise, the euro zone would not only face direct costs (via trade and banking channels) but, more importantly, indirect costs (via contagion to other vulnerable countries such as Spain), that still outweigh the potential benefits (appeasing Eurosceptic voters, avoiding moral hazard etc). A key role for Greece's survival in the euro area will be played by the ECB: without its liquidity provisions to the Greek banking sector, Grexit would be almost inevitable.]]>