June 29, 2015

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Default is certain - Grexit is not

It is the definition of a tragedy that whatever course of action the protagonists choose, the outcome is necessarily catastrophic. For the first time, the Greek tragedy may fulfill that strict definition. 

Over the course of the last weekend, the Greek government challenged the consensus, rejected the creditors' latest and final offer, imposed capital controls and a one-week bank holiday. Most importantly, it called out a referendum, to be held on Sunday, July 5. There is a moderately strong market reaction this morning - the euro and shares are down a little - but nothing dramatic. 

The question of the referendum will be:

“The Greek people are hereby asked to decide whether they accept a draft agreement document submitted by the European Commission, the European Central Bank and the International Monetary Fund, at the Eurogroup meeting held on June 25.”

As ever, forget the polls, at least the current batch. They were done before the weekend. What could stop the referendum is a resignation by president Prokopis Pavlopoulos, but he already said he won't do that now. Those opposed to the referendum could try to threaten its legality, on the grounds that Art 44 of the Greek constitution, which rules out referendums of fiscal issues, but there are exceptions for questions of national importance. And finally, a vote of no confidence could lead to a postponement of the referendum by three days. Antonis Samaras considered that, but appears to have dropped this idea. So it looks like the referendum will go ahead next Sunday.

What are the scenarios? Different authors have gone through this in some detail. There is quite a large amount of consensus on this point - with some nuances.

 

If the outcome is Yes

Macropolis argues that this scenario would give rise to another immediate bifurcation. The government resigns, paving way for new elections, which would have to be held within a month. July 26 has been mooted as a possible date. The danger of this scenario is obvious: an even longer period of uncertainty - and Tsipras may still win. This is a scenario which Hugo Dixon thinks possible in his Breakingviews column this morning, since the opposition is hopelessly fragmented. The alternative scenario after a 'Yes' vote is for Tsipras to form a different coalition. This would be our main scenario, at least initially. Tsipras primary objective has been, and remains, to hang on to power. He has a solid majority and a united coalition behind him, at least so far. He would need to co-opt To Potami and Pasok into a new coalition, to reflect the Yes vote. But none of that will make a big difference. The second programme will have expired, and the creditors will not offer him a third programme.

The thinking within the Syriza administration is firmly in favour of a reshuffle - as opposed to new elections. Just read this from Yanis Varoufakis at his post-eurogroup press conference on Saturday:

"If the Greek people wanted us to sign on the dotted line we would, even if that meant having a government reshuffle or some other kind of configuration at the level of the government. Alexis Tsipras the Prime Minister, and we the negotiating team, committed to making sure that the Greek people retain sovereignty. You have to remember that. We are the agents; the Greek people are the principals, they tell us what to do. If they tell us to sign, we will sign."

Wolfgang Munchau makes the point in his FT column that the biggest tactical error committed over the weekend was the decision by the eurogroup not to extend the programme by a few days - an act that strengthens Tsipras' hands; Munchau makes the additional point that even if Antonis Samaras were to reemerge as prime minister, that would not change as much as people think. The creditors know Samaras, and have no illusions about his record of implementing promises. They have lost trust in Greece, not only in Tsipras himself. If Samaras were to win, Munchau thinks the creditors would demand that a list of prior actions be implemented in full before they even start negotiating. And the list will be tougher. Munchau makes another fundamental point about the possibility that a Yes vote that would nevertheless end in Grexit. It would expose the fundamentally undemocratic nature of the eurozone. He writes that the biggest mistake of the weekend was the decision by the finance ministers to reject the programme extension for another week. That will give Tsipras a lot of ammunition in the short referendum campaign. 

 

If the outcome is No

As Macropolis points out, the goverment itself does not frame the referendum as a euro in-or-out question. A No vote would thus not give rise to a voluntary exit. Tsipras says a No vote would give him a mandate to negotiate a better deal. The commentators see this differently. With a No vote, the chances of Grexit are greatly increased. What will happen with certainty is that capital controls become permanent. The banks could reopen, but withdrawal limits, currently €60 per person per day, would remain in place. We noted with interest that Hugo Dixon thinks a No vote is probable while most other commentators, including us, believe that the uncertainty would favour the Yes camp.

 

Other outcomes

There are other possible outcomes. It is possible that Tsipras might back down at the end of the week, for example, if the polls point towards a clear Yes victory by Wednesday or Thursday. Our understanding is that he won't be able to pull the referendum, but he could claim on Wednesday that the eurogroup's unreasonable decision not to extend the programme by five days, if confirmed by a rejection of Tsipras' second request sent to the EU council, has rendered the referendum obsolete - since the people are asked to vote on a proposal that no longer exists, for a programme that will have expired by then. If a Yes majority crystalises, Tsipras' priority will switch to hanging on to power. 

 

Default

What will happen with certainty is that Greece will default on the IMF tomorrow. All the scenarios above would imply that Greece would also default on the ECB, when its Greek bonds mature on July 20.

 

Is Grexit inevitable?

Just as the majority of the commentators in the media didn't see the events that happened over the weekend, and expressed themselves as "shocked, shocked" that a Syriza adminsitration would reject an austerity programme, they now seem to treat Grexit as inevitable. This is particularly true for the German press this morning, which is universally awful, even - and perhaps especially - among the liberal media. What we would like to point out at this stage is that a system of capital controls, aided by a parallel currency, can sustain itself for a long time. 

It is our reading that Pavlopoulos would use the threat of resignation if Tsipras were to trigger Grexit (though in reality, that misjudges the dynamics of such an event. Grexit would not be some calm and calcuated decision, but something that becomes necessary overnight to avoid a total collapse of the economy.) More likely, Pavlopoulos could use his resignation threat to trigger elections if Tsipras clings on to power after losing the referendum as the present coalition may not be able to elect a new president (though this is not so clear either).

Our other stories

Our lead story goes through the scenarios in great detail. We also look at the details of the capital controls and withdrawal limits, and take another look at Greek bank balance sheets, and what would happen after controls are lifted; and finally, we consider the notion of the Eurogroup of 18 - and the legal basis for that curious construction.

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