A plan to avoid a Grexit

by  & , Bloomberg

Greece won’t exit the monetary union this year, in our judgment. The country’s near-term financing gap is small relative to the size of the financial aid it has received in the past, and the will to keep the union together remains strong.

We expect Greece and its creditors to find a mutually acceptable list of reforms to unlock the funds needed to keep the beleaguered country afloat. Past experience suggests that agreement could be reached at the last possible moment — just before a repayment must be made to the International Monetary Fund. Still, as the timeline grows tighter, the risk is rising that European leaders might run out of patience and trigger a messy exit from the euro area.

The Next Deadline

Greece will have to make a payment to the IMF of about 360 million Special Drawing Rights (SDRs) on April 9. That equals about 462 million euros. The Syriza-led coalition government may have to reach an agreement with its creditors ahead of that date in order to make the payment. For additional repayment dates, see here.

 

Size of the Problem

Together with the next payment to the IMF, Greece needs to find about 17 billion euros to meet its bills for the remainder of the year. That breaks down into interest payments of about 3 billion euros and debt rollover needs of about 13 billion euros. For detailed calculations, click here.

Sources of Funding

  • Primary Surplus

Greek Finance Minister Yanis Varoufakis intends to achieve a primary surplus of 1.5 percent of GDP. That should provide about 2 billion euros to help plug the financing gap.

  • European Central Bank

European finance ministers have agreed to return the profits on Greek bonds purchased by the European Central Bank through its Securities Market Programme. That should bring in another 1.9 billion euros. Those funds will only be released once Greece comes to an agreement with the group formerly known as the Troika. That leaves the country in need of about 13 billion euros in external financing.

  • International Monetary Fund

The IMF should release the 3.5 billion-euro payment linked to the sixth program review, when an agreement is reached. The review was originally scheduled to be completed by Aug. 31, 2014, according to the report of the fifth review published in June 2014. It still hasn’t been concluded. In addition, the IMF could accelerate the payments linked to the seventh and eight reviews, which were scheduled to have been completed by Nov. 30, 2014, and Feb. 28, 2015. That would generate an additional 5.3 billion euros in funds. That leaves a need for 3.8 billion euros.

  • European Financial Stability Facility

The funds from the last tranche of the aid package from the European Financial Stability Facility of 1.8 billion euros are scheduled to be distributed when the four-month extension comes to an end. That leaves a gap of just 2 billion euros.

  • The Rest

The remaining gap could be filled in at least one of two ways. The first option would be for the ECB to raise the cap on the issuance of Treasury bills. It’s presently set at 15 billion euros. The second would be to allow the Greeks to tap a European Stability Mechanism precautionary credit line, which members said on Dec. 8 they are disposed to grant.

Risks

The messiest outcome, compared with our core scenario, is that good will evaporates and Greece is forced out of the monetary union, rather than negotiating an exit. That could happen if the country were to fail to reach a compromise in time and default on a debt payment.

The ECB would probably find providing liquidity to the banking system of Greece difficult if the country were to be officially labeled a defaulter. Shutting off the liquidity tap — at a time of significant deposit flight — would bring the banking sector to its knees. The resulting failure of the payment system would force Greece to start printing a new currency. That adjustment would probably allow Greece to stand on its feet again in the years to come, though it would cause major dislocations in the short term.

Third Bailout Package

Greece still has to worry about paying the bills that will come due next year. That would involve negotiating a third bailout package after the four-month extension expires at the end of June. Those negotiations would probably result in Greece agreeing to run a primary surplus of 1.5 to 2 percent of GDP to service its debts.

Politicians across the continent seem to have ruled out a haircut on the debt held by other euro-area governments. In any case, forgiveness of that portion of the debt would have a limited effect on the Greek budget because the 141.8 billion euros in funding from the EFSF already comes with a 10-year period during which interest is accrued and doesn’t have to be paid. The interest on the 52.9 billion euros from the Greek Lending Facility is only three-month Euribor plus 50 basis points.

Room for negotiations on reducing financing costs also seems limited. To start with, as just mentioned, the servicing costs are non-existent on three quarters of the total. Extending that privilege to the funds from the Greek Lending Facility would only save about 274 million euros in 2015. That’s less than 0.2 percent of GDP.

The most likely outcome for dealing with the stock of debt held by euro-area governments is another round of extending and pretending. Syriza will leave that battle for a future government as long as that portion of the debt doesn’t curtail its current spending plans. 

Political Risks

The fallout from any potential dissent in the near term within the Syriza-led coalition should be mitigated by support from the opposition leader, Antonis Samaras. He has indicated a willingness to join a unity coalition to keep Greece in the euro area. Over the medium to long term, a risk exists that the inability of Syriza to make good on its promise to reverse budget cuts is poorly received by parliamentarians. That could breed further political instability and, in an extreme scenario, usher in a political party or faction that’s intent on leaving the monetary union. The polls suggest that Greek voters currently want to remain in the monetary union, though opinion could shift now that the costs of doing so look larger than Syriza promised.