July 28, 2015

After weeks of marathon negotiations, political uncertainty and a surprise referendum, Greece and its European creditors finally reached a tentative agreement on 13 July designed to keep the debt-ridden country in the Eurozone. The deal, which still needs to be finalized, could provide Greece up to EUR 86.0 billion in aid over the next three years, primarily for debt repayments and bank recapitalization. The cash-for-reforms agreement is seen largely as a U-turn for Prime Minister Alexis Tsipras and his anti-austerity agenda, since it contains tougher economic overhauls than were considered in July’s referendum.



On 15 July, the Greek parliament approved a list of prior actions to rebuild trust between Greece and its creditors and a precondition to starting formal bailout negotiations. The actions consisted of economic reforms, in particular related to pensions, national statistics and the VAT system of taxes. While the measures passed with an overwhelming majority—229 of 300 members of parliament voted in favor—Tsipras had to rely on opposition support for the bill and the legislation created a large rift in Tsipras’ party, SYRIZA. A number of members from the far-left faction of SYRIZA voted against the bill, including former Finance Minister Yanis Varoufakis, which led to a cabinet reshuffle in the following days. On 23 July, a second round of preconditioned reforms related to the civil justice system and banking sector passed with slightly-smaller opposition from within SYRIZA.



Immediately following the approval of the first list of prior actions, Greece was granted a EUR 7.2 billion bridge loan on 16 July from the European Financial Stability Mechanism—a much needed lifeline for the country’s depleted finances. The loan should cover Greece’s financing needs until August while the bailout agreement is being completed. In addition, the European Central Bank (ECB) raised emergency funding for the country’s banks. Both moves paved the way for Greece to begin repaying debts and reopen its banks. On 20 July, Greece payed EUR 4.2 billion in principal and interest to the ECB and EUR 2.1 billion to the International Monetary Fund (IMF), clearing arrears after becoming the first developed economy to default on a loan to the IMF on 30 June. On the same day, Greek banks reopened after being closed for three weeks, however capital controls remain in place to prevent large runs on the banks.



The next step for Greece will be to get back into negotiations with the creditors. The formal details of the third bailout still need to be ironed out and the country is aiming to complete talks by 20 August, when a EUR 3.2 billion payment to the ECB is due. Moreover, a number of unpopular reforms deemed essential by creditors still need to be implemented, including increasing taxes on farmers and raising the retirement age. However, now the burning question is whether this bailout agreement will be the last.



There is a large risk that the third bailout agreement could suffer from the same hurdles in the long-run as the second bailout did. Specifically, potential issues include political upheavals in Greece, stalling or backtracking on reforms by the government, a poorer-than-expected performance of the Greek economy—or overly-optimistic assumptions in the bailout and an inability or unwillingness to meet fiscal targets. Moreover, the IMF has been critical of the tentative bailout agreement and stated that it is not viable without debt relief. While in the short-term implementation of the bailout requirements seems highly likely given recent successes, consistent multi-year implementation over the course of the deal is what is required and remains uncertain. Michael Saunders, Head of European Economics from Citigroup adds:



“We still suspect that an eventual Grexit is more likely than not over a 1-3 year horizon. This could occur via numerous scenarios, including non-ratification of the bailout agreement (either within Greece or among sufficient creditor countries to prevent an ESM package), a failure within Greece to pass required reforms in coming months, collapse of the Greek government and election of an anti-bailout government, or a general acceptance that (like the first two programs) the third program has failed to return Greece to a sustainable path — especially given the continued reluctance among key creditors to accept hard debt restructuring (ie haircuts to the principal of debt).”



On a more positive note, while early elections do seem highly likely as Tsipras’ coalition support has eroded, there is a chance that Tsipras’ current popularity will prevent a political upheaval. Lefteris Farmakis, Eurozone economist at Nomura comments:



“Mr Tsipras’ decision to request a 3-year ESM programme and begin the implementation process means that “Greece’s political landscape will for the first time benefit from the existence of yet another unequivocally pro-European party”, no matter which path SYRIZA takes in the near future. Despite the countless unknowns surrounding the forthcoming electoral contest, a (fairly plausible) assumption that Mr Tsipras will remain popular enough to capture a large share of the popular vote (either from within SYRIZA or from the platform of a new party) could lead to reduced medium-term political risk regarding programme implementation compared with the recent past.“



Amid looming uncertainties, the economy is expected to contract this year after having grown for the first time in seven years in 2014. Austerity measures and low levels of confidence will weigh on private consumption and business investment, and downside risks related to snap elections persist. FocusEconomics Consensus Forecast panelists foresee the economy declining 1.2% in 2015, which is down 1.1 percentage points from last month’s forecast. For 2016, the panel expects growth to pick up to 0.2%.