The Greek Tragedy – Act One

The drama of Greece’s negotiations with its European creditors continues to unfold. Both sides appear to be employing brinkmanship tactics, which suggests that the needed compromises will come only at the last moment. The political reasons for these tactics are clear. The new Greek government campaigned against the existing program for Greece and won a popular mandate for that position. Voters in Germany strongly support the German government’s tough line. We continue to expect there will eventually be an agreement, but with brinkmanship comes the risk of miscalculation.

Act I of this tragedy is coming to a close. The main actors are the finance minister of Greece and his European counterparts, with the European Commission seeking to bring the sides together. After both sides stated their initial, broad, and incompatible positions, the focus moved to the immediate financing problem Greece will face when the current program expires at the end of this month. While Greece has enough funds to carry on a bit further without a new financing program in place, its need for funds will soon increase. Both sides recognize Greece will need some bridge financing until a new program is agreed.

Greece is asking for a four-month extension of the current bailout financing on condition that it would not roll back economic reforms, would continue to run a primary budget surplus (budget surplus before interest payments), and would pledge to pay its creditors in full. In return it would be granted leeway to decide on further reforms, in particular, a scaled-back privatization program and lower budget surplus targets (1.5% of output versus 3% in 2015 and 4.5% in 2016 and 2017 under the current program). Greece also indicated a need to develop a plan with its creditors to address the nonperforming loans problem of Greek banks. The Germans today immediately restated their position that any extension must be accompanied by adherence to the full conditions and commitments of the current program. Although the European Commission said the Greek request may pave the way for an agreement, the European deputy finance ministers today were united in rejecting Greece’s proposal.

In a further development yesterday the European Central Bank, ECB, agreed to a modest EUR 3 billion increase in Emergency Liquidity Assistance to Greece, much less than the EU 10 billion requested by Greece. At the same time the ECB denied Greece’s request to issue additional Treasury bills.

It seems likely that an agreement on bridge financing can be reached after some more symbolic posturing, perhaps with the Europeans agreeing that Greece can reduce its primary budget surplus target while negotiations on a revised program are underway and with Greece agreeing to hold in place the current reform effort during this period. This bridge finance agreement may be reached at the finance minister level meeting in Brussels Friday, but in our view it is more likely that a heads of state meeting will need to be called for this purpose. That agreement would bring Act I to a close, but there will surely be several more acts to this drama.

One reason these events appear to be a tragedy, even if a revised, compromise program is eventually agreed, is that the Greek economy is finally returning to growth after six years of painful recession and macroeconomic adjustment, with GDP declining more than 25% and unemployment reaching 27%. The government deficit has been reduced from more than 15% of GDP to 1%. Greek competitiveness has improved significantly, leading to exports exceeding imports and thereby adding to economic growth.

The election of the leftist Syriza-led government with its position of opposing the terms of the Greek bailout agreement, along with the ongoing difficult negotiations with Greece’s creditors, has led to a considerable increase in uncertainty about the future course of the Greek economy. While the Greek economy was able to turn upward last year, growing by 0.8%, it contracted by 0.2% in the fourth quarter over the previous quarter. It would be tragic for the Greek people, who have suffered so much, if their economy were to fall back into recession for the current year and beyond. If the debt talks succeed and the agreed conditions are not excessive, the economy is likely to resume its recovery, fueled by pent-up demand, with business investment contributing significantly. Yet the downside risks are great.

Apparently some investors share a positive view on the prospects for Greece’s economy and specifically its stock market, which is down more than 55% over the past 12 months in US dollar terms, according to the MSCI equity market index for Greece. This month to date, February as of 18th, that index is up 18%. That compares with +3.5% for Germany this month to date. We do not hold Greek positions in Cumberland’s International or Global ETF Portfolios. We are bullish on the Eurozone, however, where economic recovery is back on track, and have added to our exposures there, hedged against currency movements.

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