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Analysis

Troika must find Greek answer

Return of Athens euro fears

by Danae Kyriakopoulou in London

Tue 14 Feb 2017

Heightened market uncertainty makes a political accord on Greek debt resolution increasingly urgent – and time is running out. The economy is under pressure. The European Commission’s forecasts for Greece, published yesterday, show the economy accelerating substantially over the medium term, but this is largely due to low-base effects. Economic fundamentals remain weak. Mario Draghi, president of the European Central Bank, said last week that until European governments conclude the second review of the third bail-out, Greece will not be considered for the Bank’s quantitative easing.

But the chances of the review concluding soon are diminishing owing to the deep-seated political and diplomatic constraints affecting the Greek government and the troika of creditors that includes the International Monetary Fund, ECB, and Commission.

For much of the past 18 months, Greece had largely stayed out of the headlines. The relative calm has its origin in the country’s third bail-out, agreed in July 2015, which provided a timeline for Athens’ medium-term funding. But Greece’s return to the international front pages over the past few weeks can also be traced back to the ‘extend and pretend’ approach that the indebted country and its creditors adopted to achieve the 2015 agreement.

As I argued at the time, this was a bad deal in which all actors had to abandon pre-conceived conditions. It is no surprise that fears have re-emerged that Greece may have to leave the euro. The conditions attached for fiscal adjustment and reforms were far from the policies on which Greece’s ruling Syriza party campaigned in the January 2015 elections and the July 2015 bail-out referendum. The European creditors had to go ahead without guaranteed IMF participation in the programme, as the Fund failed to push for any form of relief as part of the bail-out. It was a classic case of politics mattering more than economics, of deferring conclusive action with a short-term solution that would become increasingly problematic.

Last week’s IMF board meeting brought a novel result: a split between the European and non-European members on whether Greek debt is sustainable. This represented a significant shift from its previous position. While the staff view that debt was unsustainable was clear in 2015, the board’s view, which prevailed at the time, was that the bail-out could go ahead without a debt relief clause.

Having made its position clear through a staff paper on debt sustainability, the Fund, through its adept 2015 move, could protect its staff by blaming any failure of the bail-out on political decisions. IMF policy is determined by its shareholders, who are represented by the board, rather than its staff. Politics matter much more to the former. In 2015, the incentives of the leadership were better aligned with avoiding a full-blown euro area crisis than with the integrity of economic models.

Decisions by the board could now change. Ted Malloch, Donald Trump’s preference for US ambassador to the EU, told Greece’s Skai TV on 7 February that he is in favour of a Greek exit from the euro area. As argued in a previous OMFIF commentary, the euro area can no longer, after the election of Trump, rely on US co-operation on monetary troubles. Meanwhile European creditors, led by Germany, are trying to avoid a Greek escalation ahead of key European elections.

A solution must come by 20 February, when euro area finance ministers meet. After that the election cycle begins, with the first poll held in the Netherlands on 15 March. Much depends on whether the creditors can give Alexis Tsipras, the Greek prime minister, a deal that he can sell to his electorate and to his MPs. The hope in Athens is that it gets a guarantee for medium-term debt relief if it promises to pass additional measures now, such as lowering the tax-free income threshold. This should pave the way for the inclusion of Greek bonds in ECB QE, allowing Tsipras to claim a victory at home and appear respectable before the electorate.

However, if there is no deal, Tsipras may give up. He is behind the New Democracy opposition in the polls. But a ‘heroic exit’ following an impasse with the creditors may be the least bad alternative for the young politician who may harbour ambitions of returning to politics later in his career.

Danae Kyriakopoulou is Head of Research at OMFIF.

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