Insight on the troubles that threat the EU and its future shape as the possibility of an EU breakdown lies ahead, by Roubini EconoTeam
Europe’s Troubles Set to Worsen
Our conversations at the IMF spring meetings in Washington indicated that Europe is still front and center for global policy makers, with the possibility of the UK leaving the EU and Greece leaving the eurozone creating serious anxiety.
Global Impact of Brexit Becoming Increasingly Evident
Brexit is worrying policy makers, given its ramifications for markets (it could trigger another risk-off episode), Greece (it might disrupt the country’s third IMF bailout) and the overall European project (it could represent the first step toward the EU’s disintegration).
Should Britons vote to cut ties with the continent at its June 23 referendum on EU membership, how would other EU countries react?
- Germany and France would be hardliners, making the UK pay dearly for its exit papers (to deter other countries from following in its footsteps).
- Spanish officials said they would prefer to re-engage with the UK even after a “Leave” vote, as they fear Brexit would provide a boost to anti-system parties across Europe, including Spain’s own Podemos.
- Italy would probably try to obtain more “fiscal flexibility” in exchange for aligning itself with Germany and France.
- Meanwhile, developed market central banks might decide to refrain from taking major policy action ahead of the EU referendum, keeping their powder dry in case “Brexit” happens. We think the Bank of England would ease soon after a vote in favor of Brexit, and other European central banks might need to follow suit. Similarly, the Fed might opt to refrain from hiking in June (the current most likely date for its second hike) if Brexit seems likely.
Grexit: More Drama Than Tragedy?
Negotiations over the first review of Greece’s third IMF program are getting tense again, with fissures emerging between Athens and its official-sector creditors. The latter expect tensions to intensify, with Greece perhaps awaiting the result of the UK referendum before making any further concessions (hoping for a post-Brexit renegotiation of its bailout deal).
In particular, the IMF refuses to accept any plan based on unrealistic assumptions, such as that Greece would be able to maintain a primary surplus of 3.5% of GDP after 2018, while at the same time pushing for more draconian pension reforms in exchange for meaningful debt relief.
- German Finance Minister Wolfgang Schäuble needs to decide whether he should force the German parliamentary commission to agree to that form of debt relief or accept that Greece will never hit its primary surplus targets. Both options are unpalatable, causing the current stalemate.
Greece wants the negotiations on debt relief to be closely tied to the refugee emergency, knowing it has some leverage there. Germany, instead, wants to keep the two sides of the discussion separated, to increase its chance of extracting concessions from Greece.
Given this background, we expect tensions to increase in the coming weeks, but will they escalate to the point reached last year? We do not think so, for a number of reasons:
- German Chancellor Angela Merkel and French President François Hollande committed to keeping Greece in the eurozone last year and will not easily backtrack from that;
- The geopolitical reasons for keeping Greece in the eurozone are even stronger this year than at the height of the “Grexit” crisis last year, given the intensification of the migrant crisis and the pact recently made with Turkey; and
- In 2015, Greek Prime Minister Alexis Tsipras’s popularity allowed him to survive his high-wire act of a referendum and early elections. This year, the rise of Kyriakos Mitsotakis and New Democracy has changed the political landscape. We think Tsipras might raise the stakes again in the hopes of securing a beneficial deal with the quartet, but he has no incentive to break off from the negotiations, given his diminished political capital.