Thursday, 10 September 2015

Greece's 3rd bail-out: make or break?

Greece's third bail-out programme was given green light in August. All went according to plan. So far.

The relevant question now is: after the failures of the previous two, what are the risks of failure facing this one? There are four main risks:

1. The banking sector's comprehensive restructuring and recapitalisation doesn't take place

Greek banks need to write-off bad debts and be recapitalised to provide financing to the private sector. Without it no sustainable private sector driven economic recovery can start.

The third bail-out package includes Eur 25bn to recap the Greek banking sector. This accounts for around 6.5% of the Greek's banking system total assets. It should be more than enough to recapitalise the Greek banks properly.

Existing shareholders in some banks (all but National Bank of Greece?) will most likely be wiped out - sorry guys, the EU's Bank Recovery and Resolution Directive (BRRD) will only enter fully into force in January 2016 but given Banco Espirito Santo's bail-in precedent in August 2014, January 2016 is too close for the EU authorities to let shareholders off the hook. Bondholders (both junior and senior) will be (partially) bailed-in. But all will be ok.

The Greek banking sector not being comprehensively dealt with and recapitalised is not a risk.

2. Primary surpluses demanded by the Quartet (European Commission, ECB, ESM and IMF) are detrimental for growth

Too aggressive fiscal targets imposed on Greece by the Quartet could be too restrictive for public spending. Social unrest would pick up new momentum. Implementing the structural reforms agreed as part of the third bail-out package become an impossible task. The programme would fail. Again.

These are the final primary surplus targets agreed between Greece and the Quartet: -0.25% of GDP for 2015 (a primary deficit) vs. 1% (surplus) that was agreed earlier in the summer; 0.5% in 2016 vs. 2% agreed earlier in the summer; 1.75% in 2017 vs. 3% earlier; 3.5% in 2018 vs.....3.5% earlier.

And there will be surely some willingness to accommodate a deviation from the agreed 2015 primary surplus target to take into account any unexpected adverse effects on GDP growth following the bank closures and imposition of capital controls in July. As long as the Greek government implements the agreed structural reforms for 2015.

There is hardly anything too aggressive and demanding here. So, no significant risks on this topic either.

3. Public debt restructuring will not take place

A silent and significant debt restructuring has been taken place since 2011 as I showed in detail some time ago ( And more is to come via maturity extensions and lowering of interest rates as long as the new Greek government implements the agreed reforms. And as soon as the first review of the third bail-out programme is favourably concluded.

With an average maturity of 31 years the loans of the new bail-out programme are a clear signal of where the debt restructuring journey is going.

Absence of further debt restructuring is clearly not a risk.

4. Lack of political will to implement agreed reforms

Mr. Tsipras went as close to the edge of the Euro cliff as one could possibly go. Seeing the Grexit abyss he stepped back and agreed to a new comprehensive third bail-out package. If we wins the upcoming general elections (20 September), and forms a majority government, not implementing something that he agreed to is surely not a realistic scenario to contemplate. Even if of one argued that he only agreed reluctantly to some of the measures in the MoU, the electoral victory would give him the mandate to implement them.

What if the opposition (ND led government) wins the election? Not much changes. With the pro-Grexit parties likely to end up with only 15% to 20% of the votes, any Greek government will have a clear mandate to do whatever it takes to stay in the Euro. And after the dramatic quasi-Grexit events in July, that plain and simply means implementing the agreed reforms.

Greece being Greece, not all agreed reforms will be implemented. However, even if the implementation ratio is 50% (instead of the rather 10% in the past) that would be good enough.

Arguably Syriza winning now would be a superior outcome for mid to long-term policy continuity purposes. If after 3-4 years in government Syriza lost the general election in 2018-2019, a new ND-led government (potentially in coalition with Potami) would tend to continue along the roughly same economic path as defined by the third bail-out programme. No dramatic reversal of economic policies would take place allowing Greece to reap the full benefits of the difficult reforms implemented in the meantime. The same cannot be said with the same degree of confidence if Syriza loses this election and wins the next one. There is always the possibility that at that point in time even a more moderate Syriza tries to reinvent the wheel, once more, and reverses some of the reforms implemented in the meantime.

Then again, will it make any substantial difference for reform implementation over the next 18-24 months who wins the 20 of September election? Not really. The Quartet's first review on the progress of reform implementation will take place in November. Greece will pass. Further debt relief will then be conceded by the EU. And the ECB will be able to extend its QE programme to the purchase of Greek government bonds. With bond spreads narrowing, capital controls slowly being lifting, foreign investors returning to the country and the economy starting to recover, Greece could well be 2016's economic suprise of the year. And with a cyclical-adjusted PE of under 5x, Greece's equity market could do much better than most expect over the next 18 months.

No one ever said that Greece is a boring country. And rightly so: over the coming 18 months it is likely to continue to be a box full of surprises. This time good ones.


  1. Good analysis but just a bit too positive in my view. You have laid out the close to best case scenario for Greece, and we all hope something like your vision comes to pass in time for Greece to catch some of the positive global growth trends.. Agree with your conclusion on point 1. However I see strong linkages between paras 2-3-4*, and a misfire on any of these issues complicates the others....Greece being Greece as you note. For instance I see more Troika/Quartet leniency towards a government that is more pro-business, and much less willingness to accommodate the socialists is they continue to treat the private sector as something evil. Accordingly, assuming there is a Grand Coalition in power later this month, Greece will be marginally better off on all counts if New Democracy is back at the helm and is allowed undo the public sector changes SYRIZA had started to implement and can openly support accelerated privatization. But we do hope Europe is correct in the core assumption that these elections don't matter and that Greece is completely bound by the July agreement.... The problem is that Greek citizens have yet to figure out their votes can translate into a maximum of a 5 degree policy change in the direction Greece must go. As folks here are now saying....Who do you want to drive YOUR Memorandum?

    *On the debt the SYRIZANS are still having a massive problem accepting there can be no up-front haircut, with most Greeks still secretly lusting such....thanks to the media which doesn't understand the power of financial engineering.

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