Germany finally admits to a third Greek bailout, but what form might it take?

It seems the German government has finally publicly accepted what everyone already knew – that Greece will need some kind of further financial assistance after its second bailout programme expires at the end of 2014. German Finance Minister Wolfgang Schäuble told a CDU election rally yesterday:

"There will have to be another [bailout] programme in Greece," in order to help the country "get over the hill" of debt repayments it faces.

Despite attempts from both the German Chancellor Angela Merkel and German finance ministry spokesmen to row back from the comments and suggest they are not, in fact, a change in stance, the remarks seem to have stuck.

What form might the third bailout package take?

• According to the IMF, Greece's total funding gap up to the end of 2015 is around €11.1 billion (5.8% of GDP) – so this can be taken as a lower bound of the funding needed. Privatisation receipts (which have notoriously fallen short) are expected to reach €7.7 billion over the next three years. Further shortfalls here could push up funding needs.

• A further extension of maturities and reduction in interest rates on the official sector loans, as suggested by EU Economic and Monetary Affairs Commissioner Olli Rehn also seems likely. However, interest on loans from the EFSF - the eurozone's temporary bailout fund - are already at cost and payments have been deferred for ten years. The IMF is also unlikely to reduce its interest rate as this would amount to a form of debt restructuring, which the IMF refuses to engage in due to being the most senior creditor. This leaves only the eurozone's bilateral loans from the first Greek bailout, the interest on which has already been reduced to around 1.5% (well below most eurozone states' long-term borrowing costs). Therefore, scope for further reduction is limited, and the benefit it could provide would amount, at most, to a couple of billion spread over a long period, as we have previously noted.

• Another widely touted proposal is to use the leftover funds originally allocated for Greek bank recapitalisation. So far, according to the IMF, Greek banks have received €40.9 billion out of an allocated €50 billion. Although it seems the EFSF expects this to increase to around €48.2 billion. It is likely some additional buffer will be needed, given the pace of increase in bad loans in Greece, meaning the amount available is likely to be between €2bn and €4bn max.

• A final idea, reported by Süddeutsche Zeitung, is that EU structural funds could be able to provide some of this funding. It’s not clear exactly how this would happen and, as we’ve noted before, we're sceptical of the idea that there is lots of excess money floating around to be easily reallocated in the EU's structural fund programme. Given that the new EU budget headlines for 2014-2020 are set, it's not clear how much more money can be squeezed out for Greece. One option would be to adjust the 'co-financing rate' (the amount the Greek government contributes to each project to gain funding) but this has already been adjusted and provided little boost to the take up of funds, which remains well below target.

Lots of questions to be answered then about the size and format of what may be the trickiest Greek bailout to date, given the tough political constraints and the on-going (very tenuous) premise of debt sustainability. An important consideration, as Schäuble suggested, will be to get Greece over its funding hump in the next couple of years (data from Greek debt bulletins):

The final point to note is the continuing German aversion to further debt relief for Greece, something the IMF and nearly all private observers accept is necessary. Within Germany, this seems to be a result of the government 'learning its lesson' from the first Greek debt restructuring, which patently failed. However, the German government seems to be learning the wrong lesson for the wrong reasons – it was not that restructuring was a bad idea in itself, but simply that all such a large amount of debt was held by Greek banks that the ensuing recapitalisation and bailout negated any benefit.

The German government clearly remains loathe to discuss any such details, meaning a clear plan is unlikely to emerge until the end of the year. In the meantime, we can’t help but wonder how the Greek public will react to the prospect of another bailout with another set of conditions attached. Could the big unknown outside the eurozone begin to look attractive once again? Maybe, or maybe not - but it may well start to factor into their thinking at some point.

Public support for the EU drops by 16% in one month: is popular support for the euro in Greece finally about to wane?

As we've noted in the past, a factor that will determine whether the eurozone can hang together in the long term is the extent to which the public in the South begins to see the euro and EU austerity as synonymous.

For example, despite everything that has taken place in Greece, this has not been the case, with a majority of Greeks consistently in favour of remaining inside the euro. The choice is instead perceived as being between austerity or some form of alternative. This is why we rightly predicted that Greece would remain inside the euro following its hectic dual elections last year (at a point when many analysts were predicting an imminent Grexit).

But is this now starting to change? 

Possibly.

A new Public Issue poll shows that 66% of Greeks now have a "negative opinion" about the EU. For a country that has traditionally has been staunchly pro-EU, that's bad enough. But extraordinarily, when the same question was asked only a month ago, 'only' 50% of respondents said that had a negative opinion  about the EU- a massive 16% increase in only a month, possibly owing to the handling of the Cypriot bailout and the renewed Troika push for civil service cuts in Greece. Those with a positive view dropped from 48% to 31% in the same space (see the graph below).

A separate poll by Marc for Alpha TV asked the question, “In case it’s not possible to improve the conditions of the loan agreement, what do you think we should do?” 53.8% answered "remain in the EU and the euro", while 41.3% said they wanted to "leave the EU and return to the drachma" (4.9% don't know). Note that this was a question about leaving the EU, not only the eurozone. Whilst still a majority in favour of sticking around, to our knowledge, there has been no Greek opinion poll to date with such a large share in favour of leaving the euro and the EU.

Incidentally, the Public Issue poll also asked who respondents wanted to see as Prime Minister. Top candidate? “None”. (see graph)

We're not drawing any firm conclusion from this, although if this trend continues it will be significant. Currently a majority of Greeks believe that things "would be worse" outside the euro. It's worth listening to our interview with leading German economist Hans-Werner Sinn, which we published today, on the prospects for Greece in the euro. One thing is clear: this won't be easy.

Another disastrous budget for Greece

This week saw the release of the Greek budget plan for 2013-2016 and it did not make for happy reading. The English version is yet to be released but below we reproduce some of the key facts and figures from the Greek report. The table below essentially sums up the report and the crushing blow it delivers to hopes of a Greek recovery:

Debt peaking at a 192% of GDP in 2014! Astonishing given that less than six months ago the EU/IMF/ECB Troika seemed supremely confident that Greek GDP could stabilise at 120% of GDP by 2020 and would peak in 2013 at only 167% of GDP. (It’s also worth checking out this FT Alphaville post which highlights just how wrong some of the previous estimates were).

It’s easy to say that Greece failed to fully implement reforms and adhere to the bailout conditions (which it did) but at some point the failure of policies themselves and the fudging of the numbers must be admitted.

To many of us all of this was already abundantly clear but the release of the official figures confirming it at least ensures that the political debate will need to be moved on – expect ‘Grexit’ discussions to return to the headlines with a vengeance.

There are also a few interesting nuggets in the budget which suggest to us that further revisions may be likely:

• Firstly, unemployment is expected to go from 22.4% this year to 22.8% next year and then decline to 17.1% in 2016. It’s hard to see how this can happen with both government and private spending expected to fall over this period, while there will also be plenty of labour market reforms which tend to increase unemployment, at least in the short term. 
• Despite dropping by 15% this year, investments are expected to fall by only 3.7% next year and then return to growth. Again this seems massively optimistic without a permanent fiscal transfer supporting Greece and remove the cloud of a Grexit which continues to deter investors. 
• Exports are expected to grow at an increasing rate over the next five years, despite the eurozone and the global economy potentially posting low levels of growth. 
• Private consumption is expected to fall by 7% next year (after 7.7% this year), and yet this is expected to be consistent with a 4.5% contraction in GDP rather than a 6.5% one seen this year. Combined with falling government spending and structural reform this is again hard to imagine. 
• Table 2.5 highlights what could happen if Greece does not implement its medium term fiscal strategy (aka. its austerity packages and structural reforms), putting debt at 220% of GDP in 2016. This highlights how easily the levels could once again veer off track if many of these unrealistic targets are not met. 

As we mentioned in our recent note, a two year extension will be far from enough for Greece and this budget further reinforces that fact. With it now out in the open, discussions over the next few weeks should focus on more than just Greece’s next two years, but the fundamental decision of whether Greece belongs in the euro.

While everyone is talking about Greece...

It may sound incredibly obvious, but the eurozone crisis is not only about Greece. Yes, Athens may be facing its "last chance" (Juncker dixit) to save its euro membership. And yes, the diplomatic offensive launched by Greek Prime Minister Antonis Samaras (see picture) to obtain a two-year extension to the EU-IMF adjustment programme clearly deserves attention.

However, while everyone is talking about Greece, quite important (and not necessarily good) news is coming out of other eurozone countries - of which, as usual, we also offer a comprehensive overview in our daily press summary.

In particular:

• According to sources quoted by Reuters, the Spanish government is in talks with its eurozone partners about the eurozone’s temporary bailout fund, the EFSF, buying Spanish bonds – but has made no final decision over whether to request the assistance. Unsurprisingly, the European Commission said that there are no negotiations under way, and a bailout request from Spain is not expected "any time soon". Right...

• According to a high-ranking official at the Portuguese Finance Ministry quoted by Jornal de Negócios, Portugal (the 'forgotten man' of the euro crisis) will not be able to meet the EU-mandated deficit target of 4.5% of GDP for this year unless new austerity measures are adopted. The main reason seems to be the sharp fall in tax revenue: -3.6% during the first seven months of the year, as opposed to the 2.6% increase the Portuguese government was betting on for 2012. The alternative, the Portuguese press suggests, would be asking the EU-IMF-ECB Troika to relax the target. Boa sorte with that one, especially since in September we will hit the point where Portugal is within one year of being expected to return to the markets. Remember how the IMF's requirement for a country to be funded for twelve months played out in Greece... 

• A Cypriot government spokesman told reporters yesterday that the island's public deficit at the end of the year will be around 4.5% of GDP – significantly higher than the 3.5% of GDP initially forecast. Clearly not good news, as this will almost certainly increase the EU-IMF bailout Cyprus is currently negotiating. Another headache for the Troika, which is due to visit the island again shortly (although no clear date has been specified yet).

• New figures published by the Irish Central Bank show that €30.5 billion or 27.2% of the €112 billion outstanding in owner-occupier mortgages at banks in Ireland was in arrears or had been restructured at the end of June, up from €29.5 billion (26%) in March. Furthermore, German Finance Minister Wolfgang Schäuble told the Irish Times that he will oppose any debt-relief plan for Ireland that “generates new uncertainty on the financial markets and lose trust, which Ireland is just at the point of winning back.”

Add the German Constitutional Court ruling on the ESM treaty along with the Dutch general elections (with the EU-critic Socialist Party led by Emile Roemer ahead in the polls) into the mix and it really looks like there will be little room for boredom in September.

Do the election results mark a turning point for Greece? Think again...

Over on the Spectator's Coffee House blog, we argue,

Things in Greece could have been worse after the election, but that fact can’t be hailed as a ‘turning point’. Assuming that Greek political leaders form a coalition and push ahead with EU-mandated reforms, which is a very likely outcome given that Greece may only have enough cash in its coffers to soldier on for another month, any such government will inevitably include parties that completely disagree on how to resolve the crisis. The only glue would be the fear of economic catastrophe.

This uneasy government would be ill-suited to withstand pressure from Syriza and the rest, who will spare no effort in blaming it for the inevitable economic pain. The threat of new elections, which would probably lead to Greece's exit from the Eurozone, will constantly hang over the country’s head like the famous sword of Damocles.

A great deal of hope is being placed on the new government’s ability to renegotiate the terms of the EU-IMF bailout programme. At the G20 summit in Mexico, Angela Merkel went a long way to play down these expectations. This suggests that the upcoming revision will largely be a superficial exercise. Greece may obtain a slight reduction in the interest rates, an extension of the debt repayment deadlines, a few billion for investment, and perhaps even be given some slack on its deficit reduction targets. However, the thrust of the bailout agreement will stay the same — and many of the conditions will remain unachievable and poorly targeted at the substance of Greece’s problems, such as the dramatic loss of competitiveness since it joined the euro, and a number of systemic flaws in the country’s administration.    

So should Greece leave the Eurozone as fast as it can? The euro crisis has proved that Greece should never have joined the single currency in the first place, and the benefits of Greece trying to re-build its economy outside the Eurozone are well-documented. However, if Greece left the euro now, the risks involved would very likely outweigh these benefits in the short term. Our estimate is that, if Greece exited today, it would need external financial assistance worth up to €259 billion — or else face the serious threat of hyperinflation and a banking sector collapse. Given the blind alley down which Europe has led Greece, this is the unfortunate reality, failing to take these issues into consideration could lead to a terrible outcome for all, including the UK. 

Having said that, the key question about the future of Greece’s euro membership will not go away; and it will have to be answered, sooner or later. The impression is that, once Greece manages to balance its budget and put its ailing banking sector back in decent shape, dropping the euro will look a more sensible, even desirable, alternative — especially if the Greek budget is to be drafted in Brussels on a permanent basis.

A euro exit may benefit Greece eventually but it won't be an easy ride

Over the weekend, we published a new briefing looking at the implications and likelihood of a Greek exit from the euro. We argued that an imminent Greek exit isn't inevitable, nor that it would solve Greece's problems - though, if managed, leaving the single currency could potentially be beneficial for the country in the long-term. Over on Telegraph blogs, we argue:

"if Greece defaulted and left the euro – perhaps following a failure to reach a compromise after the Greek elections on 17 June – it would be bad news all around:

• The Greek banking sector – woefully undercapitalised since the losses it took as part of the second bailout – would instantly collapse. Pensions would take a massive hit too. In order to avoid a complete economic – and social – meltdown, between them, banks and pension funds would need an instant €55bn injection of fresh capital. At the same time, full nationalisation of Greek banks – which has been mooted by the ‘radical left’ Syriza party – could prove pretty disastrous. The balance sheets of the six largest Greek banks are equal to 113pc of the country’s GDP – taking on all their liabilities would send Greek debt to GDP skyrocketing once more, potentially eliminating the benefits of the debt write-down.
• The new Greek Central Bank would also need to create at least €128bn worth of the new currency (63pc of Greek GDP) in liquidity to help keep Greek banks afloat as the Eurosystem withdraws its support. Hello inflation.
• Contrary to popular belief, a euro exit wouldn’t mean the immediate end to austerity for Greece either – the country would still have to find savings of at least €12bn to pay various bills, including hospital and social security expenditure vital to uphold social order.
• At the same time, the new Greek currency could devalue by around 30pc, which in theory increases chances of growth in the long-term (as the country is no longer stuck with a hopelessly over-valued currency), including a potential boost to exports equivalent to 10pc of GDP. But in reality, any potential export gain could be diminished if the ‘stub euro’ weakens (Spain springs to mind) or demand in Europe decreases further. Unlike previous devaluations in Argentina and Iceland – often used as comparisons – Greece has few natural resources or industries to fall back on, which may limit the benefits of devaluation. And remember, devaluing or removing a currency peg is not remotely the same as introducing a whole new currency. The latter is far more challenging.

So where does that leave us? Well, if Greece left tomorrow, we estimate that it could still need between €67bn and €259bn in external short-term support just to stay afloat. This could be split between the IMF, the Eurozone and non-euro countries.
The UK could potentially be involved in such a rescue package, via its IMF participation. In addition, the EU’s so-called ‘balance of payment’ fund – designed to help non-euro countries (which Greece technically would be) and in part underwritten by Britain (to the tune of 13pc) – could be activated. If the UK can get away with underwriting between €4bn to €6bn, which would be one scenario, it should count itself lucky. These would be loans, not up-front cash gifts, and if it served to stem contagion from a Greek exit, such loans would be justified.
To minimise the need for external support and risk of contagion, two steps need to be taken before Greece should even contemplate a euro exit: first, the banking sector should be recapitalised, shrunk, consolidated and restructured. Second, a primary surplus should be achieved to allow the Greek state to fund its day-to-day running costs without external help. Though this would make an exit far more appealing and – with a lot of luck – potentially beneficial for Greece in the long-term, the truth is that for Greece, whether inside or outside of the euro, the road ahead looks very rough indeed.
This is also why a new government in Greece – no matter what such a government would look like following the Greek elections – will likely reach a deal with its creditors, allowing it to remain inside the euro for now.
In European politics, the safest money is always on another fudge."