Only a few months after his election victory, Alexis Tsipras must secure a new bailout agreement for Greece and avoid a further Greece crisis. But what happens if Greece doesn’t get the bailout it needs?
Greece Crisis Avoided: A New Prime Minister, a New Greece Bailout!
Remember the date Monday, January 26, 2015. Alexis Tsipras, leader of the anti-austerity Syriza party, was sworn in as Prime Minister of Greece. Since then, the interest costs on the Greece debt are up and the amount of money held in Greek banks is at all-time lows—lower than in 2011, when the Greece crisis was in full swing and Greece’s exit from Europe was imminent.
Less than a month later (February 24, 2015), Greece secured a four-month extension to its previous funding, which was set to expire on February 28. Greece’s prime minister and the new finance minister, Yanis Varoufakis, promised to stick to agreed-upon reforms and water down their hardline anti-austerity campaign promises.
Several weeks later, on March 23, Mr. Tsipras visited Germany again and requested even more funds to overcome Greece’s short-term needs. Tsipras wants access to part of a 7.2-billion-euro assistance package, but eurozone officials are demanding a detailed reform plan—a plan Mr. Tsipras has been vague on. European officials denied the request, leaving Greece scrambling to make upcoming payments and market observers wondering what will happen if Greece doesn’t get the bailout.
Greece Debt: Hurdles to Overcome
April 9 is the first hurdle Greece must pass, as 450 million euros of loan repayments to the International Monetary Fund (IMF) are due. The real challenge comes in the summer of 2016 (June and July), when debt repayments spike to more than 40% of the country’s monthly gross domestic product (GDP). Specifically, that’s more than six billion euros of monthly repayments, in June and July, to the “troika” (the European Commission, the European Central Bank, and the IMF).
This is a steep challenge to overcome for a country whose public debt-to-GDP sits at 180% and which only emerged from negative growth in the second quarter from 2014. The odds are stacked against Greece. Without access to the 7.2-billion-euro assistance package, a default on payments is likely.
What Happens If Greece Defaults?
Greece relies on continuous funding from the European Central Bank (ECB) to support the capital requirements of its banks. That is, Greek banks must have adequate collateral against the loans they make out and the deposits on hand.
If Greece defaults on payments to the troika, a bank run is likely to ensue. While the wealthy have already stored their monies offshore, regular depositors will lose faith and choose to take their money out as well.
In anticipation of the bank run, it would be prudent for Greece to impose capital controls. In their worst form, capital restrictions, which I discussed in an earlier article, would limit ATM withdrawals, disallow the cross-border movement of Greek cash (except for businesses with proof of foreign transaction), and could be imposed indefinitely as Greece moves to an alternative monetary arrangement.
In the direst scenario, Greece is likely to revert back to the drachma. This would mark the exit from the European Monetary Union, but it may be an option worth choosing.
Greece Bailout: The End Game
The problem to date is that Greece hasn’t been able to grow its way out of the crisis. Harsh austerity measures were imposed on the country after it received a total of 254 billion euros in bailout funding during 2011. Creditors wanted to be repaid, demanding that Greece run budget surpluses. Greece managed to cut spending by roughly 22% from a high in 2010 to the third quarter of 2013. (Source: Trading Economics web site, last accessed April 1, 2015.)
But government spending cuts took away a quarter of the citizen’s incomes, slowing the economy further and making it nearly impossible for Greece to repay its obligations. (Source: Project Syndicate, March 25, 2015.)
In 2015, we have come full circle. Greece is again in desperate need of more funding and more reforms to its labor laws and pension system. It is the same story, but this time around, the hurdles may be too steep. Capital controls, along with the return of the drachma, are closing in.