Greece-Troika review: A rendezvous in Paris will not result in a deal

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Jakob Christensen, director and senior economist at Exotix Partners LLP comments on the implications of the current negotiations between the Greek government and the Troika.

The negotiations with the Troika on the completion of the current review are proving just as difficult as we envisaged in our recent research note — or in fact slightly more so (Greek GDP warrants: short-term noise provides a good buying opportunity, 23 October). The two sides appear deadlocked in their negotiations on completing the review and agreeing on a new “supporting arrangement” between the EU and the Greeks. Time is running out for an agreement to be reached before the Eurogroup deadline on 8 December. As we suggested in our October note, uncertainty about both the outcome of the negotiations and the presidential election continues to weigh on Greek asset prices, notably the GDP warrants, which have fallen further since late October, although there was a small rebound on Friday.

One of the key sticking points in the review is the budget for 2015. Despite days of intensive negotiations via teleconference, the two sides were unable to resolve their differences last week. As a result, the Greek budget was submitted to parliament on Friday without Troika approval. This closely resembles the situation last year when the Greeks also submitted their budget despite significant disagreement on the outlook — and they managed to keep fiscal developments on track, albeit with significant Troika concern and continuous close monitoring.

We are surprised by the extent of the disagreement on the fiscal outlook for 2015 and think that it will be a significant hindrance in terms of concluding the review. While the Greek side does not see a fiscal gap for next year, according to various media reports their Troika partners foresee a shortfall compared to the primary target of EUR1.8-2.5bn, or 1.0-1.3% of GDP. And the decision by the Greeks to unilaterally increase the number of tranches under the tax settlement scheme to 100 hasn’t gone down well with the Troika either, as they fear that revenue collection will suffer.

Although the huge structural and fundamental fiscal changes in Greece make fiscal projections a delicate art, we believe the differences are too wide for the Troika to accept as margin of error at this stage. While the benefits of the major tax and expenditure reforms which have been adopted are beginning to bear fruit, the full impact of the reforms is only going to be realised over the coming years, once the new rules and legislation are fully bedded in; assessing their exact impact is very difficult and prone to uncertainty at this stage. The Greek government will claim that they have proven their ability to meet the targets over the past two years during a time of radical fiscal changes and a sharp economic downturn, thanks inter alia to tight expenditure control put in place by giving the Ministry of Finance new powers and of course in continuous dialogue with Troika experts. Even if the Greek side proposes some modest measures, we think that the gap will be too big for the Troika to endorse next year’s fiscal package. Rather than insisting on large-scale savings plans which would be unrealistic, it would probably make more sense to wait and assess the situation later, either in January or after the elections in February, when more fiscal observations are available.

Is the rendezvous in Paris likely to foster enough bonhomie to complete the review at the meeting, or even before the upcoming Eurogroup meeting? Probably not, in our opinion. However, the meeting will probably allow both sides to claim sufficient progress has been made for the Troika to return after the Thanksgiving weekend and continue negotiations in the run-up to the deadline set by the Eurogroup meeting on 8 December. Furthermore, there are probably also options on the table on extending the current EU programme, as well as the subsequent relationship between the parties. We don’t think a completion of the review is possible before the Eurogroup on 8 December due to the number of issues in play and the extent of the differences, notably on the budget for 2015.

What is the way forward on the review and what is at stake for the different parties? While an immediate agreement on the review would be ideal for all parties, second-best solutions must start to be considered at this stage. If a swift completion of the review cannot be concluded in December, one of the most pressing tasks would be to approve an extension of the EU-supported programme when it expires at the end of this year. Without such an extension, the Greek banks will lose access to regular funding from the Euro Central Bank system, as well as losing out on the likely reduction in haircuts on collateral used in accessing funding. Hence such a request would have to be submitted to the Eurogroup by the Greeks at the 8 December Eurogroup meeting to allow time for national parliaments to deal with the request before they adjourn for the Christmas break. Alternatively, it may be necessary to convene an emergency Eurogroup meeting later in December if the 8 December meeting is too soon.

A delay in completion of the review is a challenge for both sides as the EU programme expires at the end of this year.

The IMF should not be too concerned about a delay until after the election: we think that it would insist on a strong policy package, a criterion that the authorities’ current fiscal package for 2015 would not meet. In addition, the IMF programme runs though the beginning of 2016, the Greeks have sufficient money to get through to June, and the IMF will know who they are dealing with after the election, hence rushing to disburse on the basis of a weak package only to find Syriza in power would make little sense. Furthermore, a ‘wait and see’ approach to assess whether fiscal developments pan out in accordance with the authorities’ expectations could reduce the need for large-scale measures in a still weak economy.

The EU Commission will have to present a relatively strong package to the Eurogroup in order to obtain approval for an extension of the programme. Some agreement over what happens on “the day after” the current programme expires may also be necessary. For the Eurogroup and national parliaments to agree to an extension, according to media reports quoting EU officials, the Greeks will have to sign a strict memorandum with the EU, committing the Greeks to the required reforms.

While the Greek government would have preferred a swift and smooth conclusion of the review to remove some uncertainty, it can claim it stood firm against unreasonable Troika demands. The downside to the extension may be that it has to agree on some kind of arrangement to follow the expiring programme.

We see three possible scenarios:

  1. Conclusion of the review by year-end: We still think that the parties will strive hard to conclude the review. The key question is how much will satisfy the Troika in terms of closing the fiscal gap. The Greeks are clearly not in a position — and don’t see the need — to adopt large-scale fiscal measures. The Greek side may propose smaller and less sensitive measures to appease the Troika. But it will clearly be difficult for the Troika to comfortably give a seal of approval given the size of their projected gap. Given the limited time available we think it will be difficult to conclude the review by year-end.
  2. Extension of EU programme through end-January and agreement on review before election. This scenario would buy the parties more time in agreeing on policies to conclude the review. The Greek government would have to apply for a six-week extension of the EU programme and discussions could be concluded in January before the presidential election. Furthermore, to close the review, the Greeks would still have to adopt the necessary measures to satisfy the lenders, including unpopular fiscal savings, which might be increasingly difficult with elections looming. A few months of additional observations may give some indication of whether fiscal data develop in line with the government’s expectations. However, based on current trends we think this is unlikely to be the case.
  3. Extension of the EU programme and completion of the review after the election. Such a solution would allow time for all parties to assess budgetary developments and then see if a supplementary budget is needed towards mid-year. Note the timing is after the presidential election.

Political outlook

We maintain our view that the most likely outcome of the presidential election is that the coalition candidate is elected. It is going to be a close and hard-fought contest, however. Despite rumbling in PASOK ranks with former Prime Minister Papandreou attempting to launch a leadership challenge, we do not think that he will draw the country into a political crisis as he did in 2012 by asking supporters not to vote for the coalition candidate; we think that the backlash, domestically and internationally, would be too great. Also, the Independent Greeks have been toying openly with the idea of aligning with Syriza and not supporting the coalition candidate; however, we think that it is still in their interest to avoid early elections as they risk being eradicated given their poor standing in the polls.

Investment implications

We maintain our Buy recommendation on the GDP warrants. In fact the warrants have fallen further since our recommendation was issued in late October.

Obviously, the ideal solution would be a swift conclusion of the review to remove one pillar of uncertainty in the outlook for Greece. Prolonged uncertainty about Greece’s relations with the Troika will weigh on asset prices to some extent. However, we think that the political uncertainty regarding the presidential election will be more of a concern for the market, and in our base case of a successful presidential election outcome for the coalition; this uncertainty may be removed in February after the elections.

But hitting the economy with a large number of new measures in order to complete the review would most definitely hurt the nascent economic recovery, and increase the chances of Syriza coming to power after the presidential elections. A delay in concluding the review may reduce the need for measures if fiscal developments are better than expected by the Troika. A political regime change would be negative for the warrants’ target price, according to our last research note.


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