Monday, 2 February 2015

Is Mr. Tsipras going to Hollywood?

Let's say that the new Syriza-led Greek government does not reach an agreement with the "troika" of European Union / ECB / IMF on the renegotiation of its debt. Let' further assume that it runs out of cash to pay its private sector creditors by the end of June 2015 (this assumes that until then the ECB will not cut off the liquidity provision to Greek banks, which will use it to refinance approx. EUR 10bn of maturing T-bills over the period). What options will it be left with?

Basically three:

1. The Tsipras led government decides to leave the Eurozone. With 70% of the Greek population opposed to this option, Syriza would in fact lose the political mandate it won in the 25th of January elections. Massive country-wide street protests would force the government to resign. Greece would be back to square one. A new government would reverse the decision and agree to a new "troika" financing package with more onerous strings attached as negotiated in a position of greater weakness. A one-sided government decision to leave the Eurozone is not an option.

2. Mr. Tsipras calls a referendum to decide on leaving the Eurozone. As emotionally as the "let's leave" campaign may be run, it is unlike to swing the current pro-Euro 70%-majority into a minority. Greek people, as unhappy as they may be with the "troika" imposed austerity, do perceive the Euro as a protection mechanism against local politicians random decision-making and corruption. And that it provides a framework for future sound(er) political decision-making and foundation for a modern and more prosperous economy.  Following a defeat in the referendum Mr. Tsipras would be forced to resign. Greece would be back to square one with events likely to unfold as mentioned in point 1. A referendum on an Euro exit is not really an option for Mr. Tsipras either.

3. Greece defaults but stays in the Eurozone. After years of austerity, Greece is running a current account and government budget primary surplus. Meaning: it is not dependent on international financing to meet its public spending needs (interest payments apart) and to pay for its imports. It's banks are dependent on ECB financing, which would be cut off shortly after the Greek government defaulted on its public debt. This could force Greece out of the Eurozone. However, this would only be the case if Greek banks needed new financing / liquidity as a result of massive capital outflows. Imposing capital controls would likely avoid it. The refinancing of existing ECB liquidity wouldn't be an issue - Greek banks would simply not repay the existing loans to the ECB invoking Greek government imposed capital controls and thus render any refinancing unnecessary. Greek could stay in the Euro despite defaulting on its debt.

Let's say that this would actually work and the Greek government would spend the primary budget surplus (4.0%-4.5% of GDP in 2015) in social programmes. GDP would grow, aggregate demand would increase but so would the demand for imports. With the current account surplus running at just around 1% of GDP, external financing would be required to pay for the higher level of imports. Who would provide it? Not the "troika", obviously. But neither would private investors (even if no default had occurred on privately held Greek debt by then) given the existence of capital controls and the uncertain outcome (and impact on private investments) of the stand-off with the "troika". With no foreign direct investment (FDI) flowing into the country to broaden its export basis and no portfolio inflows either, the external restriction would soon be felt by the Greek citizens: growth would be limited, access to external goods and services constrained. After maximum two years, it would be obvious to everyone that this strategy didn't allow the country to overcome its economic crisis. Syriza's popular support would erode. And Greece back to square one.

So, what is the alternative to not reaching an agreement with the "troika"? Simple: reaching one. How difficult will it be to do so? To answer this question we need to analyse what Mr. Tsipras wants and what the "troika", and especially the European Union, wants in exchange.

Mr. Tsipras essentially wants to (i) ease the burden of Greece's EU held public debt (65% of total) and (ii) be able to increase public spending to finance social programmes (e.g. free healthcare, housing, electricity, heating for the hardest hit by the economic crisis).

How difficult will it be to achieve these goals? It shouldn't be too difficult:

(a) A formal debt haircut will not happen. It is politically (given the difficulty to explain it to the creditor countries' electorate) and legally (no-bailout clause of Maastricht treaty) infeasible. But a soft and hidden haircut is perfectly doable. In fact it has been done over the past 4 years via maturity extensions and lowering of interest rates of EU held Greek public debt. The maturities of EU loans started being 7 years in 2010 and have been pushed to over 30 years in the meantime. The interest rate came down from Euribor + 5.5% to Euribor + 1.5%, with a 10-year interest payment moratorium (on 50% of total debt), and Euribor + 0.5% (on 15% of total debt). As a result, Greece is now paying annual interests amounting to 2.4% of GDP on its debt, which accounts for 175% of GDP. For the sake of comparison, Germany's interest payments on its public debt amount to 1.9% of GDP. France's 2.1%. Spain's 3.2%. Portugal's 4.2%. Ireland's 4.3%. Italy's approx. 5%. And back in 1998, the last year before the Euro came into existence, Greece was paying 7.4% of GDP in interests (at the time Greece's public debt accounted for 95% of GDP).

Extending maturities to 50 years with interest rates lowered to Euribor + 0.5% and a 10-year moratorium on interest payment on all the EU held public debt is perfectly achievable. And this would be a massive de facto (soft and hidden) debt haircut.

(b) Greece will be running a government budget primary surplus of 4.0%-4.5% as percentage of GDP in 2015. If the EU agrees to let Mr. Tsipras spend and additional 4% of GDP in social projects the primary surplus should shrink not to 0%-0.5% of GDP, but to......2.0%-2.5% of GDP given the public spending's likely multiplier effect in an economy not cut off from international financing (4% of GDP in public spending with a 1.3x multiplier and a 40% average tax rate on each extra Euro of GDP would generate additional tax revenues accounting for 2% of GDP).

The European Union in turn should happily agree to such extra spending. As long as it gets two things in return:

(c) Mr. Tsipras has to commit to nor roll back the structural reforms implemented in Greece over the past 4 years.

(d) Given that further significant cuts in the Greek public-administrative apparatus will be difficult to be agreed to and implemented by a Syriza government, Mr. Tsipras has to strongly commit to an overhaul of the tax system in order to fight tax evasion (estimated at 25%-30% of Greek GDP) and rise tax revenues. A strong commitment of this nature will likely imply agreeing to let a group of EU tax experts, jointly supervised by the Greek government and EU, move to Greece with a wide ranging mandate to redesign the country's tax system and put in place powerful institutions and mechanisms to fight tax evasion.

By obtaining (a) and (b) Mr. Tsipras can portray himself domestically as the great XXI century Greek hero who freed Greece from the "EU/German oppression". He will have delivered on his promises in record time. With FDI and international portfolio investments flowing into Greece a robust economic recovery will ensue. Mr. Tsipras popularity and political success will be guaranteed until at least the next general elections and an absolute majority will be an almost certainty. Will committing to (c) and (d) to get (a) and (b) be asking too much from Mr. Tsipras?

Mr. Tsipras and his economic team surely know that (c) is needed for long-term robust and sustainable growth, that the most difficult part of the job is done and that Mr. Samaras and Pasok will be blamed for it for years to come. Not him. He will just reap the benefits of the carried out painful structural reforms. Regarding (d), fighting tax evasion and vested interests is popular in Greece. And potential intrusive behaviour from an international task force of EU tax experts surely a low price to pay to obtain (a) and (b).

To assume that Greece will not reach an agreement with the "troika", and especially the EU, is equivalent to assume that Mr. Tsipras is an irrational political operator, completely driven by a radical ideological economic unsound agenda and with neither sense of reality nor pragmatism. A mental basket case.

Can someone who is stripped of a reasonable sense of pragmatism become prime-minister in a Western European democracy at the age of 40? Can someone who hasn't a firm grasp of reality lead what was an irrelevant political party to power in just four years? Can someone be the undisputed leader of such an ideological diverse group of people as Syriza's members without being a very rational and smart political operator?

Answering these question with a yes might be reasonably sensible in a Hollywood-type environment. However, Hollywood is the place where House of Cards is considered a high quality political series. In the real world House of Cards is just the Twin Peaks of the XXI century: cinematography of exceptional quality, very good first episodes and then a sudden turn which makes it a spectacular offence to common sense and intelligence.

It is very much unlikely that Mr. Tsipras goes to Hollywood any time soon.

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