Endgame in Greece: Don't Look for an Imminent "Grexit"

May 21, 2012 12:00 PM

As the countdown toward a new Greek election heads toward June 17, most analysts predict an imminent Greek exit from the euro area. Almost anything can happen, but a few possibilities are worth considering. Any newly elected Greek government will have trouble implementing the current austerity program called for by euro leaders and the International Monetary Fund (IMF). A loss of funding at least from the IMF in 2012 appears likely. On the other hand, it is also likely that Greece will remain a member of the euro in the short run, through 2012. Prospects for an outright Greek Exit—a Grexit—are no more than 5 percent.

Two main scenarios for Greece in the coming weeks depend on politics and the elections.

Scenario 1: Greece has a “second TARP vote” on June 17

The abrupt deterioration of Greece’s economic situation arose from the unexpected lack of a pro-IMF program majority in the Greek parliament after the May 6 elections. The voters delivered a stinging rejection of Greece’s established parties, instead putting on center stage the populist Syriza Party and its leader Alexis Tsipras, who advocates voiding the IMF program and the memorandum of understanding (MOU) with the fund, the European Central Bank (ECB), and the euro leadership, known as the Troika.

But the Syriza victory on June 17 is far from clear. In May the party got only 1 million votes, or 16.8 percent of the electorate, which is less than the 1.2 million Greeks voted for parties or candidates that fell short of the 3 percent of the votes that constitute the threshold for representation in parliament. In the next balloting, these votes could consolidate behind others. Moreover, the turnout on May 6 was low, just 65.1 percent. A higher turnout would not necessarily favor Syriza.

Euro area leaders are doing their utmost to turn the next Greek election into a referendum on whether Greeks wish to remain in the euro area, and not Greek austerity. As I have argued here before, the European Union will no doubt take a hard line toward Greek voters, telling them that they would be welcome to stay with the euro but that the decision is up to them—and the euro area is actively taking precautionary actions in the event of a Greek decision to exit.

Any acute instability in the Greek economy before the election date resulting from an accelerating bank run will probably strengthen the pro-IMF program parties, because it will demonstrate the potential economic costs of populist policies like Syriza’s and thus likely affect the outcome of the election. These circumstances might make it more difficult for Syriza to sustain its electoral success next month.

Many things can go wrong, but I believe that Greece will have a pro-IMF program parliamentary vote after June 17, much as the United States House of Representatives changed its mind in 2008 on the Troubled Asset Relief Program (TARP), which it backed after the financial markets reacted violently to the initial rejection. A victorious functioning pro-IMF program government might very well get minor changes in the IMF program, particularly related to austerity, provided it remains committed to implementing the structural reform components.

Are bank runs that might cause voters to change their mind worth the risk? Unambiguously yes. The euro area cannot negotiate with Greek populists now, lest such talks inspire copy-cat Tsipras’s to make demands in Spain, Portugal, or Italy, all of which would stir a backlash in Northern Europe opposing any fiscal transfers to help them with their troubles. Running on irresponsible populist platforms in the euro area must be shown to other countries as dangerous for their economies.

Second, many of the things that euro area leaders will be forced to contemplate if events in Greece escalate are actually not bad ideas. If banking troubles spread to Spain, who would oppose Madrid approaching the European Stability Mechanism (ESM) for capital support? In the extreme case of bank runs spreading across Europe, who would oppose a pan-euro area deposit insurance scheme as a remedy? No such actions will help the growth of ailing countries in this quarter, but the euro area always needs acute pressure to take the right necessary decisions.

Scenario 2: Syriza Wins and Greece Becomes Montenegro for a While

If Syriza wins on June 17, and it forms a new anti-IMF program government, the outlook for the Greek economy grows murkier—though an actual euro exit in the short run remains unlikely.

It is impossible to know the likely policies of a Syriza-led government once it comes to power. But even populists listen to the opinions of the electorate, and Tsipras is a skilled populist. He is probably sincere in saying that he and Syriza want to stay in the euro. The reason is simple. An overwhelming majority of Greeks consistently agree with that view.  This choice will of course dismay a great number of euro-skeptic macroeconomists, who claim that by staying inside the euro area Greece will forego the export-led riches associated with the huge competitive devaluation from a reintroduction of the drachma. Yet that view is only shared by a small minority of Greek voters.

The idea that Greece will somehow prosper from a competitive devaluation outside the euro area is delusional intellectual snake oil. But even a populist Syriza-led Greek government is unlikely to go against the vast majority of Greek voters and immediately take Greece out of the euro area. This matters profoundly. The European Union has no legal route to kick Greece out. Even if the euro area wanted to oust Greece, any negotiations would be lengthy, and they would occur while Greece remained inside the area.

Tsipras has offered Greek voters an appealing platform of repudiating the IMF program and also ending austerity and reform in Greece. This position would cost Greece its bailout funding. Since Greece runs a 1 to 2 percent primary deficit (€2 billion to -€4 billion) it would probably run out of money by August without outside assistance. Faced with that likelihood, a Syriza government intent on staying inside the euro area would face a choice of implementing additional immediate austerity, issuing €-denominated IOUs as California did in 2009, or seizing private assets to make ends meet. (The third choice is not impossible, given that Tsipras seems a pretty doctrinaire communist.) As California did when it sent out IOUs as personal tax refunds, a leftist regime in Athens would probably force its IOUs down the throat of public workers or other groups that it could coerce into receiving them. Seizing private assets in a country of rampant tax evasion and disguising income and assets from authorities would be very complex. In short, no options for balancing the budget will be popular among Greeks—which constitutes a serious problem for a populist government.

A further complication if Syriza repudiates the IMF program is that Greece’s banks, overwhelmed by bank runs, would lose access to ECB liquidity and repo transactions and eventually any further support from Bank of Greece emergency liquidity support, which would probably be vetoed by the ECB governing council. It is difficult to see how Greek banks could operate normally after a Syriza victory.

Without access to either bailout funds or the ECB, a Syriza-led Greece would become like Montenegro—that is, a country that uses the euro as its currency, but that lacks direct access to any economic support from euro area institutions.1

Running Greece as Montenegro is likely to be an extremely unpleasant political experience for Syriza, which campaigned on the fanciful idea that it could retain access to bailout funds without adopting  austerity and reform. Once it became clear that—contrary to the pre-election assertions of Tsipras—the euro area actually didn’t collapse from the declaration of a Greek debt moratorium or a bank holiday a Syriza government would not survive long in office. It would probably be replaced quickly by a new pro-IMF coalition or a new technocratic government, which would also attempt to reengage with the Troika and reopen Greece’s access to the ECB and financial support. The rest of the euro area would not welcome a Montenegro-like status for Greece. But even Tsipras talks a “suspension” in payments to  creditors, rather than an all-out default and debt repudiation. Fences could thus be mended once Greece changes its mind.

Scenario 2 might take longer to play out, perhaps a couple months. But the result would be the same: no Greek exit from the euro. Thus the issue facing Greece is not whether to stay in the euro, but how long to prolong its agony before making the inevitable choice.


1. Kosovo is another example of such a country. See http://ec.europa.eu/economy_finance/euro/world/outside_euro_area/index_en.htm