Why the Greek problem is far from over…

Over the last few days, there is a sense of euphoria in the global markets due to the belief that the Greek problem has been resolved for good. India has been no exception and the Nifty has celebrated the resolution of the Greek problem by jumping nearly 300 points. The question, however, is whether the Greek problem has actually found a solution? Or is it that just the inevitable has been postponed and markets worldwide are celebrating too early?

There are at least 5 open-ended questions pertaining to Greece that can actually lead to a relapse of the Greek issue…

  • Greece is going to receive close to $92 billion in aid from the EU which will be phased out over a period of time. What is worrisome is that a large part of this money will be used to repay old loans that are outstanding to IMF, ECB and to the other EU nations. The core problem of Greece will not be addressed. In a way it would be like Greece borrowing more money to repay old loans, a system that is hardly sustainable.
  • The big question is what exactly is Greece’s game plan? Greek banks have to be recapitalized. There is a huge liability that Greece runs for its retired people. How is Greece going to improve its productivity so that it stands a chance of redeeming itself sometime in the future? Once the Greek markets open, it will have to be seen whether the market is capable to act as an intermediary institution at all. With a junk sovereign rating, how will Greece manage to raise resources from the open market?
  • Greece may be repeating the mistakes of the past. Since 2010, Greece has been surviving on monetary support from EU. While other nations like Spain, Italy, Portugal and Ireland managed to redeem their economies through austerity, Greece is worse off than ever before. The question is what is the fundamental shift that Greece is undertaking to ensure that they do not repeat the mistakes of the last 5 years? The answer is “Nothing”! This effectively means that Greece will once again find itself in dire straits in a couple of years. Probably, at that point of time, the debt would have become unmanageable and the economy would have come to a grinding halt.
  • There is a very strong political and social implication to this entire course of events. Why did Greece agree to the austerity measures when they had elected the Syriza party due to its anti-austerity credentials? Greek people and the politicians realized that it was a choice between the devil and the deep sea. It was a choice between surviving after a year and barely surviving today. Obviously, rationality dictated that they focus on surviving today. But the negative implications could be huge. The Syriza party could lose its standing and Alexis Tsipras may have to step down. It is not very certain if he will be re-elected. But more importantly, as pensions get cut, social benefits get reduced and savings get eroded, the social and political unrest could be huge. That would be a huge price to pay.
  • The question, then, is why is the EU not allowing a hair-cut? The problem is that under the European Union rules, there is no concept of an official haircut. In the past, when the major lenders were European nations, they did take losses when they sold off these bonds to private parties and hedge funds. But that is not possible when the loans are owed to ECB and the IMF. The only way out, according to the German Finance Minister Wolfgang Schaeuble, is for Greece to voluntarily exit the Euro. There is no concept of ejection from the Euro and hence the only way is for Greece to quit the Euro. Greece will be wary of doing it as they will lose all the privileges of Euro membership.

In a nutshell, the Greece problem is far from over. From here on, there are two distinct possibilities. Firstly, this aid could assist Greece to pull on for another couple of years before the combination of a mounting debt burden and internal unrest will simply become too hot to handle. Alternatively, Greece may opt out of the Euro and default on its debt to the EU and IMF. That would result in huge value destruction for Greece and at the same time will pull Europe’s GDP down by 3-4% over a period of time. It is hard to say which would be the scarier scenario. Suffice to say, that the Greece issue is unlikely to get resolved that easily.

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