No Grexit for Now, But Greece’s Last Minute Agreement Could Easily Unravel

  • The agreement reached by Greece and its creditors on 13 July reduces near- term risks around a Greek exit from the euro, but they remain high. Greece made all the concessions, but more to come as this only opens door to European Stability Mechanism (ESM) negotiations.
  • The language on reducing Greek debt burden is almost exactly the same as in 2012, so no big concession on the creditors’ part.
  • The biggest risk now is implementation against the background of a deepening recession.  Parliamentary processes in Greece and other countries will also be difficult. The €50 billion in asset sales called for in the agreement is not realistic.
  • The risk of a Greek bank collapse has been reduced, as the European Central Bank will likely increase the emergency liquidity assistance (ELA) limit.  We continue to consider Greece debt crisis or Grexit risks as not being a Lehman moment for Europe

Long list of measures

Following a marathon session, Greece and its creditors finally reached a deal on 13 July, which opened the door to negotiations on a three-year European Stability Mechanism (ESM) package worth between €82-86 billion.

The statement of the Euro Summit includes a long list of measures that the Greek government needs to implement.

In order to rebuild trust, the government needs to ‘legislate without delay a first set of measures’. By 15 July, the Greek government needs to implement measures to improve the VAT system as well as the pension system. It should also introduce some quasi-automatic spending cuts in case the target for the primary surplus will be missed.

The Greek statistical agency (ELSTAT) needs to get full legal independence. The civil justice system needs to be improved and the Bank Recovery and Resolution Directive should be written down into the law by 22 July.

These are only prior actions that need to be met.

Looking further forward, the list of measures is much longer, as the Greek authorities need to implement (tougher) reform measures given the worsening outlook for the economy.

The measures should include ambitious reforms of the pension system, product markets and the energy market, as well as rigorous reforms of the labor market in order to align labor market policies with international/European best practices. Furthermore, steps need to be taken to strengthen the financial sector.

The creditors have also demanded that ‘valuable’ Greek assets be transferred to an independent fund located in Greece. The assets will be monetized through privatization as well as other means (likely operational proceeds).

The target size is €50 over the life of the new loan, half of which will be used to recapitalize the banks and the rest to be used to repay debt and support investment.

Another demand is a strengthening and modernization of the public administration under the auspices of the European Commission (EC). A first proposal should be submitted by 20 July.

As implementation is key, the statement notes that it welcomes the Greek authorities submitting a request for technical assistance from the Institutions, coordinated by the EC.

Interesting in this respect is that the International Monetary Fund (IMF) will remain involved. Furthermore, the government needs to re-examine earlier adopted legislation that run counter to previous agreements. 

Approval of the long list of measures is just a minimum requirement to start negotiations on a new ESM program. Moreover, the statement stresses that the start of the negotiations will not automatically result in an agreement, as a lot of number crunching still needs to be done (on financing needs, debt sustainability, and bridge financing).

We see the deal not as a panacea for Greece and the eurozone. The risks remain significant that Greece will need to (temporarily) leave the eurozone

However, the Eurogroup will meet on bridge financing, as calculations show that Greece needs €7 billion by 20 July and another €5 billion by mid-August.

The Eurogroup has serious concerns about the sustainability of Greek debt, but will only consider possible longer grace and payment periods after the successful completion of the first review.

In addition, it said that nominal haircuts are out of the question. This mirrors language used in 2012, so this is not a big concession to Greece.

High implementation risks

We think that the deal has reduced the risk of a near-term Greece exit from the euro, although the risk remains significant. Greece has made all the concessions by accepting the very tough measures, but this only opens the door to ESM negotiations, so more concessions are likely to come.

As such, we assess the implementation risk as particularly high.

It will be very difficult for Greece to stick to the program in the coming months, given that the economy looks set for a sharp contraction. This is not the ideal background to be implementing tough measures.

What is more, the implementation will only push the economy deeper into recession, which will also increase the likelihood that the fiscal targets will be missed.

This, in turn, will probably result in tougher new measures, or in heated debates when tranches of a new aid package need to be paid.

The timeline in the coming days is first for the Greek government to approve the deal as well as to implement the prior actions. This already poses risks that no agreement will be reached in parliament. There could be strong opposition to the measures, especially given that the Greek people voted down a much ‘lighter’ proposal from the creditors in a national referendum.

But if agreed by the Greek authorities, attention will shift to other national parliaments that also need to give their green light. In some countries (e.g. Germany) there is some resistance to the deal, so a green light should not be taken for granted.

Having said that, past experience shows that national parliaments tend to approve aid packages that have already been agreed by eurozone heads of states.

We also have doubts about the target amount of the privatization fund of €50 billion. This seems rather unrealistic, bearing in mind that the privatization proceeds in the previous agreement fell well short of expectations.

If the same thing happens this time, Greek debt will not be reduced as projected, hitting the debt dynamics.

Deal no panacea

Still, the fact that a deal was reached reduces the risk of a collapse of the Greek banking system. Although the ECB kept the ELA limit unchanged on 13 July, it could raise the limit in coming days, if the Greek government sticks to the plans.

The ECB will hold a governing council meeting on 16 July, after which ECB President Mario Draghi can outline the central bank’s view on the Greek deal, also providing more insight in how the ECB will deal with the Greek banks, and the ELA lending in particular.

Overall, we see the deal not as a panacea for Greece and the eurozone. The risks remain significant that Greece will need to (temporarily) leave the eurozone going forward. 

But if this happens, we do not think that it will be a Lehman moment for the eurozone economy and financial markets.

Exposures of the eurozone banking system to Greece are modest and relatively transparent. At the same time, we do not think other eurozone member states are in a similar situation to Greece and ready to follow in its footsteps.

In contrast to Greece, Ireland, Spain, and Portugal have already left the EU programs and their economies are strengthening.

In case of a Grexit, there is a risk that the spreads on government bonds of peripheral countries will surge to stress levels. However, in that event, the European authorities will react with force, limiting the market impact.

In the near term, the ECB could decide to step up quantitative easing (QE), but if that does not have the required impact, we would expect the central bank to activate the Outright Monetary Transfers (OMT) program. QE is skewed towards core government bonds, while the OMT could focus on ‘unlimited’ purchases of peripheral government bonds.

To qualify for the OMT, member states need to be in an ESM program. However, this includes a precautionary credit line, which has very limited conditions. All this will prevent a Grexit from becoming Europe’s Lehman moment.

About the Author

This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer. This article is excerpted from Greek Deal No Panacea, which was published on 13 July 2015. It was re-edited for clarity and conciseness. 

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Beleaguered Greek Prime Minister Alexis Tsipras. Photo credit: Shutterstock