“The Greek election over the weekend has resulted in the far-left Syriza party winning the most votes and parliamentary seats. Early indications are that it will enter into a coalition government with the right-wing party Independent Greeks, who also ran an anti-austerity campaign. The cross-political-spectrum coalition might seem unusual, but it will send a strong message to outsiders that socialists and conservatives in Greece are united against austerity.
The new government is then expected to attempt to re-negotiate the terms of its €240 billion bail-out, which is unlikely to go down well with the Troika (European Commission, European Central Bank and International Monetary Fund). The terms of the loans are already very generous, especially when compared to the terms other bail-out countries have received. There is room for further extensions on the debt, and perhaps a very small reduction in the interest rate, but these would represent marginal and insignificant changes, which would certainly not satisfy voters.
Instead, the new government is likely to focus on the large primary surplus the government is forced to run, along with some of the painful structural reforms. By reducing the surplus target, Syriza has suggested it could spend more on welfare. Also, backtracking on structural reforms will be popular with those with vested interests trying to hold on to the market power they have to the detriment of the rest of the economy. European partners are unlikely to budge on this front.
If Greece does not complete the structural reforms being prescribed, then it risks relapsing into a state where excessive government spending subsidises a hideously inefficient economy. The European Central Bank’s (ECB) new quantitative easing programme has provisions to exclude Greece should it fail to continue with reforms.
As we see it, the situation in Greece can play out in one of a few scenarios:
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Benign outcome. Syriza wins some concessions from the Troika in exchange for continuing with the reform process. The Greek economy has a small slowdown, but avoids a recession. The impact on wider Europe is insignificant.
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Syriza fails. Syriza fails to win any ground in negotiations with the Troika, and the reality of Greece’s poor finances dawns on Syriza, which is then unable to deliver the spending increases and tax cuts it promised. Syriza as a party fragments and the coalition breaks down leading to another election. The Greek economy sees a slowdown, but the wider implications are insignificant.
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Grexit. Syriza breaks off ties with the Troika having failed to reach a compromise, and then refuses to pay interest on Troika debt. European leaders decide to push Greece out by halting ECB liquidity funding to Greek banks, which in turn start to see runs on deposits. Eventually, Greece is forced to leave European Monetary Union (EMU) in order to print its own currency. Greece enters a deep and prolonged recession, with some negative spill-overs in Europe.
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Troika out, but no Grexit. Negotiations end in stalemate with the Troika which results in no further credit provision. Greece continues to service its loans, but is forced to run a larger surplus to do so. As there is no default, the ECB continues to support Greek banks, which keeps Greece in EMU. The Greek economy goes into recession with the added austerity, but spill over effects are temporary and small.
Investors have feared this outcome for some time. Syriza won the most votes in the previous election in 2014 but could not find another coalition partner, and so was forced to remain in opposition. Since then, Syriza’s leader Alexis Tsipras has moderated his campaign, by – for example – dropping the party’s agenda for exiting the euro. Euro membership is still very important for Greeks (the vast majority continue to support membership), which suggests that the new government will not wilfully use a Grexit as a bargaining position.
The wider implications of Syriza’s victory are complex. From a markets standpoint, the reaction so far has been muted. The euro is trading higher against both the US dollar and sterling (albeit after days of falls), while European bourses are a little higher, with the notable exception of the Athens Stock Exchange, currently down just over 2%. The yield on the 10-year Greek government bond is over half a percent higher today, although it is still some 2.5% lower than its recent peak at the start of the month.
Compared to when the European sovereign debt crisis first started, the markets’ contagion risk has been dramatically reduced. European financial institutions now have minimal exposure to Greece, which reduces the likelihood of a wider crisis returning. It also strengthens the hand of the Troika in the upcoming negotiations.
While financial markets may be fairly content with the situation in Greece, there could yet be political spill-overs. Syriza is the first protest party to have actually taken power in a European state. Depending on its success in coming months, it could galvanise support for similar parties across Europe. For example, the Spanish version of Syriza – Podemos - is currently polling in second place ahead of the elections due by December this year. If an anti-austerity party was to take power in the eurozone’s fourth largest economy, then the risk of a full-blown political crisis could seriously impact European markets.
In our view, the results of Greece’s elections are a setback, but not necessarily a disaster. Yet another leader promising hope and to roll-back austerity has been elected, but who will probably fail. President Hollande in France is just one example of such false hope. Greek voters are understandably suffering from austerity fatigue, which can be blamed on the previous coalition (PASOK and New Democracy) for not taking reforms and austerity seriously earlier in the crisis, causing the downturn to last longer than probably needed.
Greece’s future now depends on whether Syriza can govern in a responsible way, and recognise that major structural reforms are still needed to improve the country’s competitiveness. Unfortunately, it is hard to find optimism on this front, with Syriza promising to roll back labour market reforms, and to nationalise the banks. Meanwhile, Greece’s membership of the monetary union also depends on structural reforms, but also Alexis Tsipras’s ability to reach an acceptable compromise with the Troika. We are almost certainly going to see a stand-off in negotiations in the near-term, if only for Syriza to demonstrate its willingness to take a hard-line.”
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