What sparked yesterday's renewed concerns around the eurozone?

Over on his Forbes blog Open Europe's Raoul Ruparel provides a comprehensive analysis of the renewed concerns around European banks, centred around Banco Espirito Santo (BES), which saw stocks falling across Europe yesterday. The full post is here and reproduced below.

Firstly, there’s no doubt there are some valid concerns surrounding BES, the key ones of which are:

• The ownership structure is a mess. BES is 25% owned by Espirito Santo Financial Group, which is 49% owned by Espirito Santo Irmaos SGPS SA, which in turn is fully owned by Rioforte Investments, which is fully owned by Espirito Santo International (last two are based in Luxembourg).
• The exposure between these level is equally opaque, with the WSJ highlighting back in December that ESI was utilising different branches of its structure, including BES, to fund itself up to the tune of €6bn. Currently, BES has admitted it has the following exposure: €980m debt from Rioforte, but it also helped place €651m of debt issued by Rioforte and ESI to retail customers and €1.9bn to institutional clients.
• This debt could essentially be worthless or massively written down. It’s not clear how open BES was about its conflicts of interest and if it mislead buyers. There is a serious risk of lawsuits here. Citi has put potential total losses at €4.3bn, this could wipe out BES capital buffer and force it to raise a similar amount again.
• BES also has a worrying exposure to its subsidiary in Angola which is draining €2bn worth of funding. This is substantial for a bank with a €6bn loan book. The bank has also required a 70% guarantee from the Angolan state, which itself has a poor credit rating meaning the usefulness of such guarantee may be limited (the fact it was needed at all says a lot). This has also been weighing on the share price.

All this culminates into some very real concerns. While there are plenty of unfounded rumours flying around, the fact is they are hard to disprove because the structure of the bank and its affiliates is so maddeningly complicated. The exposure has also been continuously underestimated and hidden so it’s only right to ask, what else might they be hiding?

But all of these are very specific BES problems, why has this suddenly sparked Europe-wide contagion. I believe there are a few factors behind this:

• The market has pulled too far ahead and was looking for an excuse to pull back. The market is also in a bit of a price discovery phase, still trying to figure out how to balance the issues of low inflation, search for yield, remaining eurozone risks and future ECB action, so it can be prone to sharp moves. The lower volumes and liquidity in certain markets may also exacerbate the move. Lastly, with the recent market convergence, there is bound to be more spill over between and within markets. All to say, part of this may be the confluence of market factors and circumstances – such a situation can last but is more likely to be temporary.

• More importantly though, investors are realising that, if the bank got into trouble it would have to rely on its sovereign for help. The bank cannot afford to recapitalise to the tune of €4bn. Equally though, Portugal (in the midst of trying to find further budget savings) would struggle to stump up the cash – hence the sovereign spill over. Talk of the sovereign-bank loop being broken are seemingly premature (as I have said before). 

• On top of this, investors are also looking at a lot of uncertainty about how a bailout/bail-in might work and what the exact rules would be. The eurozone’s rules on bank bail-ins and the single bank resolution mechanism don’t kick in for some time and while the state aid rules make it clear investors will take losses the exact format is very uncertain. These two points should once again peak investors’ concerns about how such bank resolutions might be handled. Throw the political obstacles in the mix surround a national flagship bank such as BES and one might wonder how much has really changed since such questions were asked at the peak of the crisis.

• More generally, BES’s problems show some elements indicative to periphery banks (particularly in Portugal and Italy). It has a very old, complex and opaque structure and its exposures are still not well known. Too little attention has been paid to this in the past year. The loan books are also weighed down by investments and lending to zombie firms. Let’s not forget, these two countries did not suffer from bubbles but chronic low growth and high corporate debt levels – neither of which has been tackled.

There are clearly some lessons in this situation for eurozone investors and they would do well to remember the short comings in the eurozone architecture, particularly when it comes to the banking sector which is yet to be cleaned up even after six years of crisis. That said, given the specific nature of the problems it is unlikely to mark a huge turnaround in market sentiment. Sure, the market will pull back a bit but we still have the injection of the new ECB lending operations (TLTRO) to come and the hope of some positive data on the GDP and inflation front.

One final point out of all of this is to watch how BES does in the upcoming ECB Asset Quality Review (AQR) and bank stress test. If it is not seen to have been rigorously assessed and problems highlighted then serious questions will begin to be asked about the credibility of an exercise. Now, the failure of the AQR would really be the start of bigger problems for the eurozone. 

The German banking union

A deal emerges. It seems that the negotiations are finally coming to a conclusion on the issue of banking union – after just a year.

There has already been lots of coverage of the details of the deal, see in particular the excellent summaries from the WSJ and the continued coverage from the FT Brussels blog, so we won’t bother rehashing all the specifics here. Instead we’ll provide some analysis of the deal and flag up what we think are the most important implications.

First point to make to those who are frustrated about this deal not going far enough: what did you think realistically could happen? 

The deal is not that different from the previous version which we laid out here, although a few (if not all) of the unanswered questions have been cleared up.

What’s new?

• Earlier this week an agreement was reached on the structure of the funds. It was, as expected, decidedly German. A €55bn fund will be built up from levies on the financial sector between 2016 and 2026. In the meantime, any funding required to aid banks above bail-ins will come from national coffers or ESM loans to sovereigns. Only after 2026 will a centralised fund be created and while there may be some mutualisation, it is yet to be defined and will be subject to future negotiations. There is also scope for national funds to lend to each other but this is to be defined in an intergovernmental treaty.
• The decision making process will be thus: as supervisor the ECB recommends a bank be resolved, the board of national resolution authorities devises a plan and votes on it ( any release of funds will require approval  two-thirds of voting countries contributing at least 50% of the common fund). This will then have to be approved by the Commission. If there is a dispute at any stage of this process the Council of EU finance ministers will decide on simple majority (if not then it will approve through a ‘silent procedure’).

What does this mean for the eurozone?

• Well, we’re seriously at risk of repeating ourselves here, but here we go. A deal is positive and necessary. That said, the process remains incredibly complex and still seems highly national or intergovernmental. If there was a serious failure of a large cross border bank, such as we saw with Dexia, would the process really be any smoother or simpler than last time around?
• The funding remains minimal and only enough to cover the resolution of one or two medium sized banks. It will also not be available for some time and certainly will have little role in helping to deal with any recapitalisation costs outlined by next year’s stress tests.
• Taking a broad view, it’s easy to question how cross border this ultimate banking union is. The single supervisor under the ECB will only cover the largest 130 banks. The resolution mechanism will cover the same banks, plus another 200 or so which are cross border. However, there are around 6000 banks in the eurozone, and the very large majority of these remain under national purview.
• Generally, this also raises questions about how effectively the ECB can do its job as national supervisor. While the cracks in the system could push it to be harsher to ensure there is not a systemic crisis, it also poses problems given the current issues on bank balance sheets. It is crucial that next year’s stress tests are credible, if the ECB shows signs of insecurity about the ability to deal with a large bank recapitalisation it could raise questions about the process.
• Clearly, given the intergovernmental nature and the prevalence of national governments it is likely to be insufficient to break the loop between sovereigns and banks in the eurozone.

How about for non-euro countries?

• Again we have outlined these points before. It seems that they managed to secure specific protections to ensure they will never be on the hook for eurozone banks, which is good but also the absolute minimum that should be expected.
• The use of an intergovernmental treaty is tricky. It side-lines these countries somewhat but also shows the limits of what the eurozone can do within the EU treaties.
• The creation of the resolution board as a new agency within the Commission does raise some concerns. It is clear it should be its own separate institution for the eurozone only, however, the lack of willingness to open the treaties has created this system. If the eurozone continues to push new institutions into older ones and distort the structures of the EU for eurozone use, it could become problematic. It also creates a complex and ineffective decision making procedure for the eurozone as is clear above.

Winners and losers

• Germany. Plain and simple. For all the talk of a compromise earlier this week, it was incredibly minimal compared to how closely the plans as a whole match the German desires.  Think back to the original Commission plan, which was incredibly centralised. We said then it wouldn’t fly with Germany and it hasn’t.
• The structure is intergovernmental, has minimal pooling of funds, is built up overtime, excludes smaller banks, does not include direct bank recapitalisation from the ESM and has a large bail-in element. All key German demands. They have made a vague promise to have some sharing of funds in a decades time, the details of which need to be negotiated over and may be limited to an intergovernmental treaty.
• If there are any losers, then it is likely to be France and the Mediterranean bloc. They were pushing for significantly more pooling of funds and a more centralised process. That said, France did previous publish a joint vision of the banking union with Germany, which is not a million miles from the current structure. The deal also allows them some more scope to use bailouts rather than bail-ins if needed – something else they were keen on. 

As we have noted recently, 2014 is likely to be another year where governments come to the fore in eurozone. 2012 and 2013 were the ECB's years, where its actions held the euro together. With the focus now on growth, more emphasis will fall on the governments of the eurozone to develop a new structure and strategy to put the bloc back on a sustainable footing and a path to prosperity. 

Eurozone inches towards banking union but may need to resort to intergovernmental treaties

Eurozone finance ministers yesterday took a belated step towards the key part of the banking union, the single resolution mechanism (SRM), with many reports suggesting that the broad outlines of an agreement have emerged.

We’ve written about the background to this extensively, see here and here for example. As a recap, a deal was expected to be completed by the end of the year so that the framework is in place for after next year’s ECB Asset Quality Review and EBA bank stress test. This now looks unlikely, with technical details being ironed out into next year, but there is still hope for a political agreement at the EU Council on 19 December.

What are the key points of the latest agreement?

• The latest official draft of the plans was published early last week and things don’t seem to have changed massively.
• A board of national resolution authorities will make recommendations on how to resolve banks (after the ECB as supervisor recommends the need for action). The Commission then decides whether the plans are adequate or not.
• There will not be a centralised fund, at least not immediately. As in previous plans, one will be built up over the course of a decade to €55bn, through undefined levies on the financial system.
• A network will be set up between national funds allowing them to lend to each other and take action when there is a crisis. This may be governed by a separate intergovernmental treaty, to assuage German concerns over its legality.
• Taxpayer-backed funds remain a last resort, in particular European funds (either through the network or the ESM, the eurozone’s bailout fund), with bail-ins being the initial response. The plans for bail-ins, under the EU’s Bank Recovery and Resolution Directive, could be moved forward from 2018 to 2016 to help appease Germany further.

What is still yet to be agreed?

• Numerous points remain unclear, not least, who has the final say if the Commission and national authorities disagree. If it involves national funds, it is almost certain to be national authorities.
• The exact process for triggering the use of funds remains unclear, particularly in a situation where the resolution process involves a large cross border bank.
• More importantly, if a new treaty is needed, the details of this need to be thrashed out – as we saw with the fiscal compact, this can take time and will itself require a tricky negotiation. It also needs to be decided whether this will be incorporated into EU treaties, as is planned for the fiscal compact.
• There continues to be talk of the SRM and its rules applying only to larger banks, similar to the setup of the ECB’s single supervisor.

Has Germany really moved that far?

• Reports suggest a shift in the German position is the key factor behind the compromise. While Germany has clearly shifted a bit, it has also got plenty of things it wanted.
• Looking back at the proposal laid out by German Finance Minister Wolfgang Schauble in the FT in May, Germany has secured the following – significant national power, increased role for a board and less for the Commission as well as limited use of taxpayer funds, with no central fund. It could also potentially secure an SRM focused on larger banks and a quicker introduction of bail-in rules.
• It has of course compromised on its view that the treaties need to be adapted, after its position took a blow somewhat from the recent legal opinion on the issue. It has found a halfway house with the intergovernmental treaty, giving it some further legal protection.

What would this deal mean for the eurozone?

• As we have said before, progress towards a deal is positive. But the deal still suffers from some key short comings namely: the system will not be in place for the immediate aftermath of next year’s stress tests, the system is still reliant on national authorities and ad-hoc measures as well as suffering from constraints in terms of reaction time in a crisis. 
• Any funds, be they national or European or ESM, remain short of what is likely needed to help backstop and resolve any large failing banks in the circa €33 trillion eurozone banking sector.
• We remain unconvinced that this will be sufficient to break the sovereign-banking loop which has intensified during the crisis (breaking it remains the stated goal of the banking union) – national politics and money still has a huge role to play in this system.
• An important point to consider is that, given the current setup of the eurozone banking system, bank bail-ins remain, for the large part, national affairs. While this is separate to the sovereign-bank loop, it does highlight the tight feedback loops within many eurozone economies and could intensify the problem of nationally systemically important banks. This may change over time but is not guaranteed.

What would it mean for non-euro countries?

• The use of an intergovernmental treaty is interesting and could have ramifications. While it is far from ideal for the eurozone, it does side-line the potential influence and control of non-eurozone countries.
• One potential upside is that the eurozone will not be able to force through its own institutions under the single market article (Article 114) which does highlight the limits to how far they can stretch this.
• The ad-hoc part of the agreement does fragment the process and fails to provide a systematic blueprint for how future institutional changes will address the EU/eurozone conundrum.

Bank bail-in plans: is France becoming nervous about being left alone with Germany?

As we have pointed out repeatedly, those who think that the eurozone is one German election away from a full banking and fiscal union (which includes a surprising number of British eurosceptics) should have another look around Europe.

As we noted last week, the latest draft of the bank recovery and resolution directive left plenty of questions unanswered.

[Background - this is the proposal which looks to establish a clear and standardised pecking order for losses in the instance of a bank failure. It is not the full 'banking union' proposal, which involves some form of combined backstop. Despite being first suggested as far back as 2010 and with a proposal put forward last summer which was largely ignored, this has become an important piece of legislation since the Cypriot crisis.]

That EU finance ministers failed to reach an agreement after 18 hours of talks on Friday is therefore not entirely surprising. What is perhaps slightly more surprising is the dividing lines and in particular which countries found themselves arguing the same side.

We highlighted before where each country broadly stands on this issue. This does not seem to have changed much, although the focus of the discussions has. Previously, much of the emphasis was on ‘depositor preference’ – i.e. when and to what extent uninsured depositors would face losses during a bank bail-in. Not exactly surprising given the Cyprus debacle.

A broad consensus seems to be emerging around a structure which protects insured depositors completely and gives added seniority to those uninsured deposits held by individuals and small and medium size enterprises. With the pecking order broadly settled, focus has shifted to the level of flexibility allowed within the structure, in particular whether bail-ins should be automatic or whether there should be sizeable national discretion to decide on which format to use.

This debate has seen the EU split into two broad groups: 

• One led by France, the UK and other non-eurozone countries, arguing for greater flexibility and national discretion – although presumably for different reasons, the UK because it fears its financial sector is larger and more varied than many in the eurozone and France because it is keen to keep open the option of a bank bailout due to fears automatic bail-ins could increase funding costs (souveraineté). 
• The second group is led by Germany and the Netherlands, both of whom are keen to limit flexibility to allow for a standard framework across the eurozone and also partly because they fear governments will put domestic political needs above those of the single currency as a whole. This is a trust issue as these countries' taxpayers may one day have to stand behind the continent's banks.

Ignoring the technical details for a bit, the wider political dynamic at work here is fascinating. France is actually on the side of the non-eurozone countries. This is bending assumptions as it's usually France that is the keenest on doing stuff at the level of 17 rather than 27, as Paris is proportionally stronger in that smaller constellation. Germany, on the other hand, prefers 27 to 17, for the opposite reason.

There seems to be good reason to expect some greater flexibility for non-eurozone countries, with the idea reportedly gaining support towards the end of negotiations.

Now, we don't want to read too much into this but first, this dynamic suggests that France could actually find itself isolated within the eurozone (we're looking forward to that FT headline). Secondly, as we have mentioned in the past, perhaps this is another indication of how Paris - who used to see the euro as a way to lock in Germany - is actually getting quite nervous about losing the UK as a balancing force in the EU.

As ever in Europe, there's always that political sub-story worth keeping an eye on.

Where will Cypriot growth come from?

This is now emerging as the key question for Cyprus following the severe mishandling of its bailout. The financial services sector, along with real estate and related businesses, which accounted for around 30% of Gross Value Added in the economy is now essentially gone as a source of growth.

Cyprus’ main trading partners, Greece in particular, remain mired in recession. Its two largest banks – key employers – will be restructured and unemployment will undoubtedly rise. Meanwhile, the government will be cutting spending and raising taxes, laying off public sector workers and embarking on some strict labour and product market reforms – as part of the standard Troika bailout package. Many of these reforms are needed but as we have seen across Europe, when combined with other impacts mentioned above, a downward spiral can be created.

The key hope for growth remains tourism. However, with the euro remaining strong and the prospect for political and social unrest in Cyprus still high, it is difficult to see a huge boost in this area. It will continue to truck along but is unlikely to fill the gap left by other areas of the economy shrinking. As we have discussed before, the prospect of growth from large gas revenues remains a pipe dream for now.

With all of this in mind we have put together a comparison of some of the previous growth estimates, along with the implicit ones included in the latest troika report and some of OE’s initial (optimistic) projections (click to enlarge).

All of this remains uncertain, depending on when capital controls are removed and how investors respond but it does not make pretty reading. All previous hopes for the economy are off the table and expectations need to be severely adjusted. The Troika's estimates are very optimistic, particularly in terms of returning to rapid growth in 2015 and 2016. Furthermore, if the growth estimates included in the bailout prove to be overly optimistic it means Cyprus will, just as Greece did, require further financial assistance.

Cyprus closes the shutters as it announces capital controls

Some more details coming out about the much talked about capital controls in Cyprus (details via @MatinaStevis and RANsquawk):

• Will include limit on cashing cheques (but will be able to deposit cheques).
• Time fixed deposits will not be able to be redeemed during the period of capital controls
• Credit card transactions capped at €5k per month
• Limit to cash transfers outside Cyprus of €3k per person per trip.
• Applies to all bank accounts
• Valid for 7 days from Thursday, will then be re-evaluated.

We have already noted that these controls are pretty severe and have the potential to have a substantial impact on the economy. Below we list a few more thoughts:

• The fact that they are focused on limited external flows rather than internal transactions could be positive as it may help avoid a massive liquidity crunch in Cyprus.
• That said there could still be a very quick withdrawal of funds from banks, with people keen to hold cash instead. This could further destabilise the banks.
• Removal in 7 days seems optimistic, for two reasons. Firstly, the bank restructuring and recapitalisation may not be completed by then. But more importantly, the fears which would motivate massive outflows go further than just the banks. People will look to move money out of Cyprus because the financial sector has been massively shrunk and no longer looks an attractive investment. Furthermore, the economy looks consigned to a long period of economic contraction and its debt load may quickly become unsustainable. Lastly political unrest may grow. None of these motivating factors will be gone in a week.
• The lack of limit on cash withdrawals is a positive, although this could quickly change, especially with demand for cash likely to sky rocket.
• Many companies still use cheques in Cyprus, not least to pay employees, so limiting them could hamper the normal functioning of business. That said, since they can be deposited, this is mitigated a bit, although that only holds as long as people trust that they can access deposits - not clear they do at this stage.
• According to this via Zerohedge, any commercial transaction above €500 which sends money abroad will need to be proven to be in line with usual business practice. This will introduce a significant amount of time consuming paper work into the life of many everyday exports and importers. 

We’ll update the blog with more thoughts as more details become clear.

The Cypriot bailout: A catalogue of farce

Having followed the twists and turns of the Cypriot bailout for the last couple of weeks we’ve been struck by how – even by the standards of eurozone crisis management – it has been spectacularly mishandled often with farcical results (FAZ's Klaus-Dieter Frankenberger described it as "hara-kiri crisis management"). Here's our highlights:

Sunday 17th – The blame game begins 
The tentative agreement between Cyprus and its creditors was only a day old when the different parties tried to shift the blame for the politically toxic levy on small insured bank deposits. German Finance Minister Wolfgang Schäuble kicked it all off by seeking to distance the German government from the decision by blaming the Cypriot government, the ECB and Commission, which in turn prompted a series of denials from everyone else. The suggestion was that it was actually the Cypriot government who opted to include small savers in order to avoid hitting wealthier depositors (mainly Russians) even harder. The blame game continued throughout the week.

Monday 18th – Gazprom steps in with an alternative bailout? 
Following the acrimony over the agreement, it was reported that Russian energy giant Gazprom approached the Cypriot government the same weekend with an offer to fund the €10bn necessary to restructure the Cypriot banking sector in exchange for rights to Cypriot gas reserves. Although the story fitted in nicely with the geo-political tension narrative, it was quickly denied. Despite that, the rumours of a Russian bailout continued to be batted around for the entire week - none of which proved to be true.

Tuesday 19th (Afternoon) – Cypriot Finance Minster’s non-resignation 
On Tuesday Cypriot Finance Minister Michalis Sarris flew out to Moscow to see if he could secure more favourable terms than those offered by the eurozone. While he was there, rumours began to fly around on twitter, seemingly substantiated by respectable news outlets like Kathimerini Cyprus, that he had resigned as he no longer enjoyed the confidence of President Nicos Anastasiades. Confusingly, further rumours began to circulate that Anastasiades had rejected his resignation. However Sarris later told Reuters that there was “no truth” to the original rumours.

Tuesday 19th (Evening) - Cypriot Parliament rejects bailout deal after days of negotiation
Originally scheduled for Monday, the Cypriot parliament’s vote on the deal negotiated by the eurozone finally took place on Tuesday evening after attempts at further postponement failed. The parliament voted overwhelmingly to reject the deal, with not a single MP voting in favour. Of course, the democratic vote is itself not the issue but it was farcical that the deal was pursued for four days before being put to a vote when it was clear it would need to be altered again. Not exactly effective crisis management, especially since the 'No' vote raised questions over Cyprus' place in the euro.

Thursday 21st - Cypriot ‘Plan B’ shot down immediately
Following the vote above, Cypriot officials sought to cobble together a ‘Plan B’ to keep their chances of a eurozone bailout alive. Options on the table included the creation of a solidarity fund securitised with social security fund reserves, state assets, Church property and expected natural gas revenues. However this was shot down immediately by the troika as it was feared that it would not lower Cypriot debt to sustainable levels. Adding to the farce, the WSJ reports that Sarris (still in Moscow at this point) wasn't returning calls from his eurozone peers. By Friday, the deposit levy was back on the table bringing negotiations full circle.

Saturday 23rd – Russia to retaliate by freezing European assets? 
With it looking inevitable that Russian interests would be badly burned however the Cypriot bailout was finally structured, the Guardian reported that former Kremlin advisor Alexander Nekrassov warned that “Moscow will be looking for ways to punish the EU. There are a number of large German companies operating in Russia. You could possibly look at freezing assets or taxing assets”. As usual, this was later denied.

Sunday 24th – Infighting within the troika
The negotiations also saw severe strains developing between different members of the EU-ECB-IMF troika with the latter (with German support) allegedly resisting attempts by the Commission to water down Cyprus’ own €5.8bn contribution to the bailout. The FT cites an IMF official as saying that “The commission keeps trying to work with [Cypriot leaders], to help them put something on the table, even if that something doesn’t add up”, although another source adds that the two sides have “kissed and made up”.

Sunday 24th – Cypriot President's resignation bluff backfires 
Unlike the non-resignation of the Cypriot Finance Minister, this really happened. Reuters cites a senior official as saying that this took place during a particularly heated exchange concerning the plans to restructure the country’s banking sector and the WSJ reports that at that point Anastasiades was calmly told by other leaders "to pack up and leave" if he wasn't ready to cooperate (he didn't).

Monday 25th (Afternoon) - Dijsselbloem's accidental honesty makes markets plunge 
You’d have been forgiven for thinking that with a deal finally having been hammered out, the situation would have settled down a bit. However, Eurogroup chief Joroen Dijsselbloem had other ideas, suggesting in an interview with Reuters and the FT that the Cypriot deal could become a template for any subsequent bailouts and bank restructuring in the eurozone. This saw markets around the world tumble for fear of further write-downs, particularly in Spain and Italy. Dijsselbloem then looked to row back from his comments reiterating that Cyprus was “specific” and that he was not even aware of the English word ‘template’ which had been widely attributed to him - although given this specific word was used by the interviewers we're not sure we entirely believe him. His comments got a mixed reaction - he was backed by the Commission and Finnish PM Jyrki Katainen - who said 'bail-ins' should be part of the eurozone's crisis management strategy - but ECB Executive Board member Benoit Coeure said that he had been "wrong" to suggest this.

Monday 25th (Evening) - Banks to stay closed even longer
It was originally announced that Cypriot banks would re-open on Tuesday with the exception of the two biggest - Bank of Cyprus and Laiki -which would re-open on Thursday. However, later that day, Cypriot authorities changed their minds and announced that all banks would remain closed until Thursday (this was just the latest of the many extensions to the bank holiday and the numerous other delays throughout the week).

Given that the final outcome of all of this was a plan which will likely slam the Cypriot economy and significantly reduce the standard of living (albeit while reducing moral hazard somewhat), it is hard to see the whole week other than an array of botched diplomacy and naive negotiations.

Cyprus update – halfway to a deal, but the biggest obstacle remains

It’s looking as if there will be a deal in Cyprus, although there are some big obstacles to be crossed to get there and it is likely to go down to the wire.

Last night the Cypriot parliament voted to approve a few bills which will make a significant bank restructuring possible and allow the government to install capital controls if it sees necessary, here are the key points of what was approved (and what was not):

• Plan to wind down Laiki bank – good assets and insured deposits below €100,000 will be shifted into a good bank which will be merged with the Bank of Cyprus. Bad assets along with uninsured depositors above €100,000 will be put into a bad bank – these depositors could lose as much as 40% of their money.
• Ability to enforce capital controls – these are wide ranging from limiting non cash transfers to turning standard current account deposits into time fixed ones, and pretty much anything else the government deems as necessary for ‘public order and safety’.
• The creation of a solidarity fund – this will not play a large role in the bailout deal, since it was already rejected by the EU/IMF/ECB Troika as an alternative to the deposit levy.
• No deal on the bank deposit levy – Eurozone finance ministers will meet on Sunday in Brussels with the Cypriot parliament only likely to vote on a deal after it has been cleared at this meeting.
• Bank of Cyprus has survived being ‘resolved’ for now.
• The Greek bank Piraeus will take control of the Greek parts of Laiki and Bank of Cyprus.

These measures are expected to raise just over €2bn (maybe more, we’re waiting on firmed details on the solidarity fund). That still leaves €3.5bn+ to be raised to meet the €5.8bn target set by the Troika – although reports yesterday suggested this may have been raised by €0.9bn due to worsening forecasts for Cyprus. Below we outline our key takeaways from the deal.

The largest obstacle to a deal remains: Clearly, this will once again come down to the deposit levy. With a smaller amount needing to be raised, it is likely to fall only on €100,000+ deposits. As we noted yesterday a levy of between 12% - 15% looks likely, although given the bank bailout plan it could hit some big Laiki depositors especially hard. Kathimerini reports that the levy could be pushed higher and focused on a smaller group of depositors. Ultimately, though, with few alternatives left now a levy on largest depositors seems the least destructive option (but still far from ideal).

This will go down to the wire: The ECB has set a Monday deadline for a bailout deal or it will cut of liquidity to Cypriot banks. The banks are due to open on Tuesday but this could be extended if no deal is found. As long as the banks stay shut (and with use of the capital controls, see below) they may be able to buy a few days to reach a deal, allowing the ECB to reverse its decision. Still, it will be a messy few days with the Cypriot parliament unlikely to vote on the deal until the it is approved by the Eurozone and assured of passing. If the deposit levy is only on large deposits, it should gain support from DIKO (the junior coalition partner), while reports suggest some opposition members could abstain or be absent from the vote to allow it to pass.

Still, this has been left very late and the decision to approve the above measures first seems to be putting the cart before the horse. This is not too surprising though (since clearly these were easier options to push through) and reminds us of other parts of the crisis – such as the decision to approve the ESM before the EFSF was revised to be fit for purpose.

The capital controls are severe: The government has significant leeway to limit the flows of capital. People have rightly been asking questions of whether this, de facto, moves Cyprus out of the single currency. Ultimately, money is no longer fungible between Cyprus and the rest of the Eurozone and, at this point in time, it’s hard to argue that a euro in Cyprus is worth the same as a euro elsewhere. The real problem though may not be imposing the controls but removing them, as WSJ Heard on the Street points out. It is hard to see how the Cypriot economy will be able to function properly with these strict controls on and at some point questions will surely begin to be asked if it would not be better off with a devalued currency outside the euro.

Why is Bank of Cyprus not being ‘resolved’? Reports suggest the Cypriot government has fought hard to stop the bank having the same fate as Laiki. This may be because it is the largest bank and a large employer in Cyprus, but it is could also be because it remains very close to the government and is the home for some of the largest Russian depositors. In any case, avoiding the tough decision to fully restructure the banking sector is likely to make things more difficult in the future.

Greek banks are getting a very good deal: The branches of Cypriot banks in Greece have around €22bn in assets and account for 8% of all deposits in Greece and 10% of loans. Clearly they are sizeable and hiving them off helps reduce the size of the Cypriot banking sector relative to GDP and reduces the cost of the bailout. It also protects the rest of Greece from contagion. That said, Piraeus is picking up a very good deal, not least because Cypriot exposure to the Greek crisis was a key driver of the current problems Cyprus faces. The purchase was done at a symbolic €1 but the cost of recap is €1.5bn. Funding will come from the Hellenic Financial Stability Fund (the Greek bank recap fund) and the Cypriot bailout programme – €950m from the former and €550m from the latter. So these banks, investors and depositors avoid any losses despite many being entangled in the Greek crisis. The fact that Piraeus bank shares were rocketing yesterday is a clear enough sign of who did better out of this deal.

The deal has come full circle and has been very poorly managed: as we noted yesterday, we are basically back to a mix of the deal proposed by the IMF (bank restructuring) and the Eurozone (deposit levy) last Friday. The impact the events of this week will have on Cyprus should not be underestimated – there will be a huge outflow of capital (or will be whenever the controls are removed) and significant political upheaval. This has been poorly handled by both sides – the Eurozone failed to listen to the Cypriot government and was complacent about the impact of Cyprus on the wider Eurozone economy. The Cypriot government has fought to hang onto an impossible business model, focused on big finance funded by foreign deposits, and has looked to play a risky geopolitical game. Unfortunately, the ones that lose from all this are the 800,000 people who live in Cyprus.

Trying to find two more years for Greece

Ahead of today’s meeting of eurozone finance ministers we thought we’d (finally) get round to posting some of our thoughts on the last week’s leaked Troika report on Greece. The report, as may be expected, left much to be desired – and we’re not just talking about the copious glaring gaps where the eurozone and the IMF could not agree (the missing new debt sustainability analysis being the more prominent). The firefighters are fighting amongst themselves as one paper put it.

The report suggests that the cost of providing Greece with a two year bailout extension will be €32.6bn – very much in line with our estimates of between €28.5bn and €39bn. Interestingly, up to €20.3bn of this total is due broader problems with the original bailout programme, with the troika suggesting only €12.4bn will specifically be for the fiscal adjustment. This may not seem like it matters much but it highlights that the financing issues don’t just come from fiscal issues but also low growth, increasing arrears, banking sector problems and more.

Below we list a few other concerns from the report:

- The unemployment figures, as in the recent Greek budget, seem to be hopeless optimistic – potentially more so than before, since the Troika see unemployment in 2014-2016 being 0.4% below where the Greek government does. Elstat (Greek Statistics Agency) put unemployment at 25.4% at the end of August, while the Troika expects it to be 22.4% by the end of the year. A 3% drop in unemployment in a few months? That seems impossible anywhere but particularly in the current Greek economy.

- The report expresses some deep concerns over the banking sector not least the “plummeting” deposits and the likely need to run down capital buffers due to significant levels of bad loans. However, it still concludes current levels of recapitalisation should be sufficient – we’re sceptical.

- Despite, finally cutting defence spending, Greece still spends the third most (as % of GDP) in the EU. This continues to seem an obvious place to make savings, particular with NATO still going strong.

- The collapse in real investment of 40% since 2009 is staggering if not surprising, yet the forecasts for investment both in the troika and budget reports only looks ever more optimistic because of it.

- Government arrears continue to mount up, topping €8bn now. Despite presenting a significant challenge to wind down in the near future, these could also represent a drag on the domestic economy since most of the money is owned to domestic firms. 

That is to name but a few from an incomplete report – i.e. there are plenty more to come.

As for the outcome of today’s meeting, we have low expectations as usual. The target is for a political agreement on the releasing the next two tranches of Greek funds (worth €44bn). This doesn’t sound much of a stretch but it will require confirming Greece has completed the necessary ‘prior actions’, as it claims, while the IMF is hesitant to release any more funds until it has settled on a plan which sticks to its view of Greek debt sustainability. The final part will be tricky with the IMF and the eurozone still seemingly someway apart on what they see as sustainable (despite the two of them also being someway apart from the rest of the economic and financial professions).

A deal on how to fund the two year extension in the Greek bailout will likely need another meeting, while the release of funds still has to withstand the hazardous approval process of the German, Dutch and Finnish parliaments.

Expect the debate over the issues above and more to dominate for another few weeks.

Revising the Greek bailout: Two more years of extend and pretend?

Open Europe published a new flash analysis on Friday, which looks at the prospects of a revision to the Greek bailout. It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

The €28.5bn comes from: an extra €14bn due to slower deficit reduction, an extra €12bn from reducded privatisation receipts and an further €2.5bn from increased government arrears (unpaid bills).

We examine six key options for filling this gap:

1. A reduction in interest rates - which looks very likely but could only deliver €2bn - €3bn.

2. Increased short term debt issuance and more austerity - this looks possible and could deliver anywhere between €15bn - €20bn.

3. Extending length of loans to Greece - unlikely, it could raise €9.1bn in the short term, but on net it would give zero reduction.

4. ECB forgoing interest and/or profit on its Greek bonds - looks very unlikely, but could yield €1.15bn - €2.3bn (interest rate cut) and/or €14.25bn (forgoing profit).

5. Bond buybacks - again very unlikely, but it would mark a much larger step than simply covering the funding gap, as it could deliver €45.65bn overall and €17.15bn after the two year extension is paid for.

6. Write-down original eurozone bilateral loans -  this would be a huge step and could provide €26bn to €52bn but looks very unlikely to be approved, especially as it would support in national parliaments. 

Overall then, its hard to see how the gap will be filled without some larger decision being taken over the future of Greece in the eurozone. To read the full note, click here.

Where does the ESM stand?

Keeping track of the European bailout funds is hard enough, let alone trying to figure out when the changeover between the two largest ones, the EFSF and ESM, will take place.

Originally the plan was for the ESM to come into force on 1 July. However, this was then adjusted to the 9 July with eurozone leaders hopeful that they could announce it following their meeting that day. Now even that looks optimistic. Below we outline the state of play for the ESM treaty in the relevant parliaments:

Ratified: France, Greece, Slovenia, Portugal, Finland, Slovakia, Belgium, Netherlands, Luxembourg, Spain, Austria, Cyprus and Ireland

In the process of ratifying: Italy and Germany

In the next month: Malta and Estonia 

So when will it come into force? 

The next obvious target is the newly announced Eurogroup meeting on 20 July. One important point to remember is that it really comes down to Italy and Germany since, once it is ratified by members representing 90% of the capital subscription, it will automatically come into force. However, the process in these two countries is still uncertain and putting a definite date on completion is tricky.

In Italy the Senate needs to vote on it first, before the lower house can approve it, although there is no vote scheduled for the next week at least (the agenda gets updated on a weekly basis).

In Germany, both houses of the parliament have approved it, however, the Constitutional Court has asked the President to delay signing off on it due to the large number of challenges against the legality of the treaty – something which he agreed to. The court will analyse these challenges (thought to be around six distinct complaints) on the 10 July, although this could take a few days to complete. It will then decide whether to issue a temporary injunction against the treaty if any of the cases have merit. This seems unlikely and even Eurosceptic MPs such as the CDU’s Wolfgang Bosbach have said, "The judges do indeed decide only according to legal and constitutional criteria, but they also know what kind of impact a categorical 'no' would have in terms of foreign policy and financial policy."

So the situation is still unclear in the two countries that matter, but will hopefully become clearer in the next couple of weeks. There is still plenty of opportunity for a surprise but ultimately it looks increasingly likely that the ESM will be in force towards the end of the month. Whether Spain and Cyprus will be able to wait until then is even less certain though, and as we’ve heard today (and covered before) using the EFSF to disperse the funds throws up plenty of problems in itself (such as Finnish collateral demands).

Update 05/07/12 16.50

During his statement on the EU summit earlier this afternoon, Mario Monti has urged the Italian parliament to complete the ratification of both the fiscal treaty and the ESM "by the end of the month." Italian news agency AGI notes that only some 40 (out of 205) MPs from Silvio Berlusconi's party were listening to the statement. 

Update 05/07/12 15.30

It looks as if Malta has actually ratified the treaty, although in practice that makes no difference to when the ESM will come into force.

One final point to note is that, if the ESM does come into force quickly enough and does disperse the Spanish bailout, these loans will still be senior to other Spanish debt. The recent summit only concluded that loans which are issued by the EFSF then transferred to the ESM will remain pari passu (same seniority) with other debt.

A great way to run down a bailout fund?

Ahead of the summit today the proposals for the EFSF/ESM to start purchasing sovereign debt began rearing its muddled head again, with some indication that this is actually one of the few things that could be agreed at the summit. We hate to be party poopers but as we have already noted (at length) this is a confused idea and will likely provide little help relief to those countries embroiled in the eurozone crisis. Below we outline some of our key concerns with the plan:

• The capacity will be tested: this role was previously filled by the ECB. Markets know that the ECB can provide an unlimited backstop and will rarely test its resolve in keeping yields down. However the EFSF only has around €250bn left, while the ESM has a lending cap of €500bn (as we have shown though this will also not be fully operational for some time). In any case markets are likely to test the resolve of these funds, meaning they may spend more than is needed and may be less effective than the ECB was. 
• Will deplete the funds of the EFSF/ESM: further to the point above, the money in the bailout funds will be severely depleted reducing the capacity for them to fully backstop countries which may need full bailouts. Particularly a worry if Portugal needs a second bailout, Greece a third and Spain possibly a full one on top of its bank rescue package. 
• Subordination: if ESM purchases bonds other debt of the recipient countries will become junior. This increases market jitters. Would be less of a concern if these purchases solved any of the issues but they only simply delay them at best.
• Secondary market purchases: if the buying is on the secondary market, the benefit is limited in terms of countries actually being able to issue debt. Still rely on domestic markets and the sovereign-banking-loop in problem countries may become more entrenched. 
• Primary market purchases: if done in primary market, then this will be a direct transfer between countries and could lay the groundwork for debt pooling, something which could cause political outcries across northern Europe. 
• Risk transfer: holders of peripheral sovereign debt will likely see this as an opportunity to sell off their holdings at a higher than expected price, shifting risk to the eurozone level. 
• De facto Eurobonds: the funds will issue bonds to raise money to buy debt off struggling countries. Building on the two points above, this means that investors will sell national debt and buy European backed debt, again essentially creating a de facto European bond and debt union. 
• Conditions: must come with clear conditions otherwise could be self-defeating (removes incentive to reform). Furthermore, if, as is currently the case, countries must enter an adjustment programme to allow the EFSF/ESM to buy its bonds, there could be significant stigma attached (again reducing the benefit).  It could also mean other countries picking up the slack if a government does not properly implement its own fiscal policy (however, without a clear say on the spending programmes).

All in all then, a very mixed bag. At best this plan could provide some temporary relief to high yields but the side effects could be large and frankly these funds just aren’t big enough to fulfil this role (and their other roles) on a consistent basis. Besides, even if some time is bought they are still yet to outline to what end it would be used – better then to agree on this before starting to run down the one of the few backstops still in place to the eurozone crisis.

Does European solidarity have a new champion?

Apparently, Cameron told the BBC the following this afternoon:

"I understand Angela Merkel’s difficulties and her political difficulties because the Germans have run their economy very effectively over many years. But it’s their currency, they need their currency to work, so they need to have guarantees from other parts of the eurozone that they’re putting their house in order, but there has to be solidarity as well."

Solidarity? As long as it doesn't involve Britain itself of course. Not. Smart. Politics. 

Do not adjust your television set, this is not a Spanish rescue (despite looking an awful lot like one...)

Well, that was the line that Spanish Economy Minister Luis de Guindos was spinning yesterday. Sorry Luis, this is essentially a Spanish rescue - external funding sources filling a gap which the state can't (check), monitoring of a large chunk of the economy (check), involvement of all the big international organisations (check - EU, IMF, ECB etc.), the list goes on.

Meanwhile, the oft absent Spanish Prime Minister Mariano Rajoy held a press conference today, declaring the package a 'victory' for the euro and stating that if it were not for the current government's reforms it would have been a full bailout package. If this is a victory (finally dealing with a glaring problem after four years) then we don't want to see a defeat, but at least Rajoy made a public appearance this time. That said, in the midst of the worst crisis his country has faced since the financial crisis hit, Rajoy is now jetting off Poland to watch Spain vs. Italy (a mouth watering prospect admittedly but his timing could take some work), while the likes of the Education Minister are heading to Roland Garros to watch Rafael Nadal - the Spanish government not quite in crisis mode then, we're not sure if that should inspire confidence or not...

In any case, as we predicted over two months ago, European assistance to help Spain deal with its banks is now official, so what does this rescue mean for Spain and the eurozone, below we outline some of the key points and our take:

The plan
Spain will access a loan from the EFSF/ESM (the eurozone bailout funds) which it will use to recapitalise its ailing banking sector. The money will be channelled through the FROB (the bank restructuring fund) but will still be a state liability (it will not go directly to the banks). However, unlike the other bailouts it will not come with fiscal conditions but only conditions for reforming the financial sector.

Open Europe take:
Firstly, the ESM will not be in place in time to provide the loan (the treaty is yet to be ratified by numerous countries and has faced many delays) so at least initially it will come from the EFSF. As others have pointed out, this is important because ESM loans are senior to other types of Spanish debt while EFSF loans are not. This may make things easier to start with (as it removes the threat of legal challenges based on clauses in other Spanish sovereign debt which could be triggered if it suddenly became junior), however, Finland has already raised concerns over its exposure and role in the rescue - an issue we tackle in more detail below.

The lack of additional fiscal conditions is fair given that Spain is already subject to a deficit reduction programme and that this is ultimately a financial sector problem. There are questions over conditionality and moral hazard though - we would like to see bank bondholders and shareholders sharing more of the burden (bail-ins) to ensure the necessary reforms take place. As things stand its hard to see how the banks will 'pay' for this capital, particularly given the Spanish regulators previous failures (during and after the property bubble).

De Guindos confirmed that the funds would be counted as Spanish debt, so Spanish debt to GDP could be about to jump by 10% in the near future and given its current path this could put Spain over 90% debt to GDP (the level beyond which sustainability becomes questionable) much sooner than had been anticipated. This will require adjustments in its reform programme and lead to increasing market pressure.
 
Size - is it enough?
This is the key question - the total amount has been put at "up to" €100bn. That is much higher than was suggested by the IMF assessment released on Friday night, which suggested €40bn.

Open Europe take:
It sounds like a big number, but upon closer inspection it may not stretch as far as many expect. Consider that Bankia requires €19bn, while three other very troubled cajas need around €30bn (Banco de Valecia, Novagalicia and Catalunya Caixa) meaning half the money could already be eaten up, leaving only €50bn for the rest of the huge banking sector.

This compares to around €140bn in doubtful loans, and a total €400bn exposure to the bust real estate and construction sector. Doubtful loans to this sector total around €80bn currently, but we expect house prices to fall by a further 35%, broadly meaning that the number of doubtful loans could easily double. On top of this we have further losses on mortgage loans as well as losses on other corporate debt and a decrease in the value of Spanish debt held by banks. So huge number of issues - putting a clear figure on it is difficult due to the difference between tier one capital and 'loss provisions' (tier two capital). But even if this €50bn is given in tier one capital and stretched to increase provisions its hard to see that it will be enough given the huge exposure to mortgages and the bust sectors, especially at a time when growth is falling further and unemployment continues to rise.

Finland and Ireland - flies in the ointment?
If the EFSF is used (which looks likely) the Finnish government is obliged to ask for 'collateral' as it did with Greece - the noises coming out of Finland suggest it will, especially given its objection to 'small' countries bailing out 'larger' ones. Ireland has also suggested that if Spain is able to avoid fiscal conditions on its bank bailout then it could request similar treatment (i.e. a loosening of 'austerity').

Open Europe take:
The Finland issue will get messy, as it did in Greece. It will add another complex layer to negotiations, while politically it will help the (True) Finns who are already launching a campaign against further bailouts. It could also lead to legal challenges - as we pointed out with Greece, it could trigger 'negative pledge' clauses on Spanish bonds given that they essentially become subordinated to Finland's claim on Spain. Not guaranteed, but a legal grey area which adds to the confusion.

As for Ireland, they have a fairly strong case here. Ultimately, their fiscal troubles stemmed from bailing out their banks, something Spain is now able to dodge thanks to external help. Ireland already feels that it is paying a huge price for protecting the European banking system - this will only add to this ill feeling. Given Ireland's perceived 'success' in Germany some flexibility may be forthcoming but we doubt enough to assuage Irish anger.

Impact on the UK?
The IMF will only play a 'monitoring' role, meaning the UK will not be liable for the money provided to Spain. However, given the links between the UK and Spanish banking systems it is imperative that the problems in the Spanish financial sector are finally dealt with - whether that will happen this time around is yet to be seen but given the points above it is not off to a great start.

Impact on the eurozone - Open Europe concluding remarks:
Markets responded positively to rumours of external aid for Spain on Friday afternoon, but, given the points above, a huge amount of uncertainty remains which will keep markets jittery and increase pressure on the eurozone. That is far from needed given the uncertainty surrounding the Greek elections. Given the ongoing assessment of the actual needs of Spanish banks the rescue will now enter a state of limbo as attention turns back to Greece, in the meantime Spain is likely to find it difficult to access the market (since this is broadly an admission it cannot raise any substantial funds itself).

Questions will also arise over the strength of the eurozone bailout funds - Spain guarantees around 12% of them, surely its guarantees are now worthless or would do more harm than good. Additionally, now that one of the larger countries has asked for support pressure will intensify on Italy (particularly with the falling support for the technocratic government and the slow pace of reform).

The beginning of the end game in Greece?

At some point you have to wonder if Greece just enjoys the limelight…

This weekend’s election was expected to be relatively predictable with the largest parties forming a coalition and eventually adhering to the latest EU/IMF bailout package. Most eyes were on the French Presidential election and its impact on the Franco-German axis. Unfortunately, as we predicted, there were still a few surprises in store in Greece. Here’s the (almost) final result:

New Democracy – (18.86%) 108 seats

SYRIZA – (16.77%) 52 seats

Pasok – (13.18%) 41 seats

Independent Greeks – (10.6%) 33 seats

KKE (Communist party) – (8.48%) 26 seats

Golden Dawn (far-right) – (6.97%) 21 seats

Democratic Left – (6.1%) 19 seats

The biggest surprise is clearly the huge rise in SYRIZA’s share of the vote and the drastic fall in Pasok’s share.

In our post in the run up to the elections we laid out three scenarios: a stable ND-Pasok coalition, an unstable coalition leading to new elections where ND win a majority and an unstable coalition which falls leading to a cycle of elections where no-one can win a clear mandate. Those three scenarios clearly still hold, but the probabilities have definitely changed. Previously, the likelihood ran in order, however, now the second and third scenarios are looking increasingly probable.

ND and Pasok only hold 149 seats, short of the 151 majority they need. The Democratic Left has ruled out joining a three-way coalition. This makes new elections (probably in June) essentially inevitable as there is no stable coalition to be formed.

However, given the showing in the elections it is hard to imagine ND, or any party, gaining a clear majority. Given the strength of the anti-austerity feeling in Greece it is unlikely that these results would be a one-off. The anti-austerity parties only look likely to gain ground in subsequent elections, making a stable coalition less likely. This analysis suggests that a cycle of elections looks increasingly probable in Greece.

What does all this mean for the eurozone?

More uncertainty, that’s for sure. Germany and the EU have already both come out to reiterate the need for Greece to maintain its commitment to the latest bailout packages, stress that keeping Greece in the euro requires strong participation from both sides (rather ominous if you ask us).

Unfortunately, this looks unlikely, even if by some miracle ND and Pasok manage to form a workable coalition at some point. ND leader Antonis Samaras has already come out saying that he will “modify the memorandum [of understanding]” with Greece’s creditors to focus on growth. This can probably be seen as the start of his next election campaign but will still send shivers down the spines of German politicians.

A renegotiation of some form looks on the cards and will not be well received. Samaras would still be the EU’s preference given his history of strong rhetoric but then still signing up to the bailout programme. The alternatives are not appealing from eurozone leaders’ perspective: either there is a cycle of elections leaving no government in place to implement the reforms or the anti-austerity feeling grows so strong that a SYRIZA led government of some form comes to power, signalling the end of the bailout programme for good.

There is a confluence of factors here which increases the prospect of a Greek exit from the eurozone. The broader feeling in Greece although still in favour of the euro is shifting strongly against austerity – how this tension will play out is unclear but the usual fall-back of broad public support for the eurozone looks shakier than it has ever been.

Since the last round of poisonous bailout negotiations the eurozone and financial markets have been preparing for a Greek exit, if not publicly than definitely behind the scenes. The stance against any renegotiation and flexibility on reforms has hardened from eurozone leaders. Furthermore, Greece is approaching a primary surplus, the point where an exit and a full default look slightly more attractive as the country could (at least in theory) survive without access to financial markets or direct support.

Greece’s future will not be decided in the next few days but the coming weeks and months could well settle its place in the eurozone once and for all. This election may not provide many answers, as we expected, but it could mark the beginning of the end game in Greece.