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Insight: Greece and the Troika

 

Another Summer of Grexit?
Disagreement between the Greek government and its creditors on Greece’s fiscal targets for 2018 and on the design of a “contingency” plan if the targets are not met has resulted in renewed deadlock. EU officials are frustrated with the lack of progress on some key reforms and the constant pushing back of deadlines for key deliverables in the last memorandum of understanding.

However, street protests and internal divisions within the ruling Syriza party are an obstacle to reforms being approved. The Greek side is wary of the creditors’ unending demands for more austerity, particularly after having delivered what it considered harsh but final measures.

Greece’s payment due to the European Central Bank on July 20 is the absolute deadline for the different sides to resolve their differences.

This Time Is Different—the Creditors Are Divided

Unlike in previous years, the three parties involved in the discussions—the Greek government, the EU creditors and the IMF—have three different “red lines” and three different sets of solutions to the conflict. The EU and IMF have usually hidden their differences over the bailout package in the past, but have become more vocal over their differences of opinions, further complicating the process.

IMF Wants Debt Relief and Pension Cuts

IMF Managing Director Christine Lagarde has already said that the IMF finds the 3.5% primary surplus target imposed on Greece as “unrealistic”—it regards 1.5% as a more sustainable goal. If it is to continue lending to Greece, the IMF wants to see debt relief offered as a “carrot” and cuts to pensions as a “stick.” This might seem to be the most reasonable solution, but is unlikely to materialize due to political bottlenecks.

Thus, we think the IMF might choose to remain on the sidelines and not directly participate in the program. However, the driving force behind the EU creditors, Germany, wants the Fund’s full involvement.

EU Creditors Want the IMF and More Cuts, but Don’t Care How

For the EU’s part, as long as Greece implements the pension reform agreed in July 2015, it is not insisting on further pension cuts, unlike the IMF.

That said, certain issues are complicating the EU’s internal decision-making.

  1. German Chancellor Angela Merkel’s position is much weaker domestically than a year ago, and she cannot afford to be seen as being lenient on Greece.
  2. If the UK’s referendum of EU membership results in “Brexit,” this would allow Tsipras to demand more (or, rather, force Germany to accept fewer cuts). If it happens, Tsipras would most likely be tempted to use fears over the EU’s disintegration to his benefit by asking for debt relief.
  3. Greece is key to the migration crisis. Although the deal between the EU and Turkey has partially resolved the crisis, it could yet fail, if the EU fails to deliver on its promises to Turkey—i.e., the removal of visas and the provision of €3 billion in aid. If the deal does collapse, migrants could start returning to Greece, which would prompt Tsipras to ask for more fiscal flexibility to house them.

Greece: Okay With Tax Hikes, but Not With Pension Cuts

For its part, we believe the Greek government has three options before the July 20payment deadline: 1) negotiate and accept a watered-down version of the deal; 2) take the new deal to a referendum; or 3) call snap elections, which would act as an effective referendum on the deal.

Options 2 and 3 seem unlikely given the ruling Syriza party’s sliding poll numbers. Thus, we still believe that Option 1 is the most likely, but passing more measures through the parliament will become increasingly difficult, with Syriza’s coalition partner ANEL already complaining that enough has been done.

What’s the Most Likely Outcome?

The refugee crisis has highlighted the importance of preventing state failure in Europe. As a result, there will be a stronger sense of solidarity among eurozone member countries on not allowing “Grexit.” EU creditors are more likely to be lenient on where the cuts come from, but will probably resist any debt relief at this point.

This is acceptable to the Greek authorities but not to the IMF, as the latter insists on debt relief as a starting point (along with deeper cuts to the pension system). However, debt relief could be made contingent upon successful reforms and an improved fiscal balance, and this could be enough to bring the IMF back to the table. There are a number of ways which all three parties could yet come to agreement, and our base case remains that this will happen.

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