With cash buffers again running low, and only little time to pursue their commitments to reform, the time has come for Greece to walk the talk. The reform list proposed in the Eurogroup agreement of February 20 seems like a good starting point. These reforms could help with new official loans, address tail risks, and increase long-term potential growth.
As things currently go, Greece cannot muddle on for much longer than June. Europeans government will need to approve a new programme for Greece, which includes new loans. This programme will most probably include new unpopular measures and reforms against promises made during the elections. If the Greece government does not tilt towards more genuine efforts of reform, it will becomes more and more likely that it will be forced to exit the Euro.
We can consider three possible scenarios: a positive one, a neutral one, and a negative one. In the most positive scenario, Greece commits strongly to the new reforms, starts seeing positive growth paths and stays a member of the Eurozone. The neutral one will be the one we have seen for the past few years, where Greece will keep muddling on, does just enough to meet obligations. This scenario is not likely to be sustainable for long. Lastly, the negative scenario: in this scenario there will not be a new deal between Greece and the European institutions. This will probably lead to a bank run, strict capital controls, and eventually a Eurozone exit.
The strong euro support polls indicate that a positive scenario is likely. However, Greece is currently headed for a negative scenario. Something has to change during the negotiations to get Greece back on track. Perhaps a negative shock is what Greece needs to reach consensus over reforms.
The positive scenario
In the positive scenario, Greece starts implementing key reforms consistent with the February 20 Eurogroup agreement, since all mainstream opposition parties have already committed to support these reforms in parliament. This means that for the first time since the crisis, Greece will be approving reforms in the parliament by an overwhelming majority.
Furthermore, Greece will immediately receive more official funding to deal with the heavy loan maturities due in the coming few months. On top of that, the ECB will start accepting Greek assets below investment grade as collateral again, other European countries will prove a strong commitment to do what it takes to keep Greece in the Eurozone.
The neutral scenario
The neutral scenario would be a slow-death scenario, which is similar to what Greece has experienced in recent years. However, now risks would be souring, as in this scenario Greece commits to just enough reforms to keep on par with the demands made by the other Europeans countries and the IMF. They just manage to not default on the short term but lack true reform to support the structural recovery so badly needed.
The markets will be extremely harsh towards Greece which basically means they do not have any market access. The Greek banks remain at the mercy of ECB liquidity support. Uncertainty persists and/as the ECB remains the lender of last resort for the Greek banks. This scenario will most likely prove to be unsustainable. The economy will not be able to survive this scenario for very long. Uncertainty and persistent risks for a sovereign default increase every month, ending in a bank run.
The negative scenario
A negative scenario will unfold if Greece fails to demonstrate credible reform commitment the next couple of months. The European countries and the IMF will suspend the current programme, the ECB will refuse to continue increasing the Emergency Liquidity Assistance (ELA) , the loss of bank deposits accelerates which will trigger a full bank run, and Greece defaults to both the IMF and the ECB. However, it is possible that one or more of these shocks forces the Greek government to go back and seek a deal with the rest of Europe. In this scenario the much spoken of Grexit will become inevitable this year. Either Europe will offer it as an option, allowing Greece to remain in the EU, or it will become Greece’s only option to avoid a complete collapse of the economy.
The road ahead
Greece will probably start of in either a neutral or negative scenario before we have a chance to see the good scenario and the economy will have suffered in the meantime. Greece will need substantially more official funding in this case. Moreover, the probability of a shock (either bank run or a partial default) would be very high in this case.
One thing that is clear is that the government cannot deliver on pre-election promises to stop austerity, restructure the Greek loans to the official sector, and roll-back some of the most unpopular reforms of the adjustment programme.
The danger of these unpopular events is that it could bare political cost and fear, which in turn leads to a rejection of the new reform programme by politicians fearing a political loss of face. However, Syriza has promised to keep Greece in the Euro and to implement structural reforms that previous governments failed to implement. Indeed, tax reform and safeguarding fair market competition by fighting corruption and eliminating monopolies and oligopolies are flagship reforms in Syriza's programme. These are of key importance in the reform list of the Eurogroup’s decision.
If political indecisiveness leads to a referendum for the new loan arrangements with European institutions and the IMF, this will most likely have a positive outcome, since there still is a broad public support to remain a euro country.
The Eurozone’s crisis resolution framework and its functioning are very specific and have been approved by European institutions and country parliaments. We expect the European institutions to insist that all sides should respect this process and framework. This means that Greece cannot deviate from the targets, conditions and monitoring mechanisms imposed by the Europeans institutions and the IMF.
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Gelein has been interested in the financial world and global economics since high school. For over 3 years he has been a member of a university investment team, of which one year he was the treasurer.