European leaders have agreed measures with Greece to provide bridge financing and open discussions about an ESM package, subject to upfront conditions being met. The deal addresses most of the immediate risks, but we do not believe it removes the likelihood of Grexit.
The key outlines of the compromise deal are as follows. Greece will be given fresh loans from the European Stability Mechanism (ESM) to meet its financing needs over a three-year period, which the euro zone leaders estimate at €82bn-86bn. In return, the country will have to implement a package of structural reform and large-scale asset sales.
Familiar promises of structural reform and asset sales
It appears that an earlier list of reforms compiled by finance ministers has been whittled down to six key priorities, which the Greek government will need to pass through parliament by July 15th. The priorities for reform are: the value-added tax (VAT) regime, the pension system, the bank resolution framework, the national statistics agency, the justice system and fiscal good governance.
Greece will also be required to establish an independent fund, to which state-owned assets will be transferred and then either privatised or used to generate income. The exceptionally optimistic target is that this fund will free up €50bn over three years, which will be used as follows:
- €25bn will go towards recapitalising the banking sector
- 50% of the remainder will be used to pay down public debt
- the other 50% will be used for investments to stimulate growth
Grexit still looks likely in medium term
Although there are near-term risks—the Greek parliament will need to approve these measures within days, and the deal also needs to be ratified by parliaments in Finland, Germany, Estonia and Slovakia—the deal probably means that Grexit has been taken off the immediate agenda. However, we continue to believe that Grexit is more likely than not over the medium term, for several reasons:
- Debt challenge to worsen: It still looks hard for Greece to restore competitiveness and grow while remaining inside the euro zone. Many of the structural reforms recommended in the Eurogroup’s proposals make sense and would be good for Greece—but the results of previous austerity measures do not inspire confidence that such a programme will lead to sufficient growth to make Greece’s debt burden sustainable.
- Implementation looks difficult: The Greek parliament is likely to vote through the measures given the extent of the pressure the country faces, but practical implementation will be hard to monitor and assess. There can be no guarantee that the region will not find itself in the same place in six months’ time.
- Political risks will continue to increase: The approach taken by Germany and others over the weekend of negotiations leading up to the agreement may have been necessary to secure a deal on terms that were acceptable in the European north. However, it is likely to come at significant political cost. We expect the deal to pass in the Greek parliament with the support of opposition parties, but there will be significant fallout within the governing Syriza Unifying Social Front (Syriza) and among the electorate at large. There is a risk that support for remaining within monetary union “at all costs” diminishes significantly.
We continue to believe that Grexit is more likely to occur than not (60%). The risk of a short-term exit has diminished, but the severity of the conditionality being demanded of Greece, coupled with the erosion of trust between Greece and its euro zone partners, means that implementation risks have intensified significantly. We expect that Greece will leave the euro zone over our medium-term forecast period (that is, before 2019).