Europe Shouldn’t Lose Its Head Over the Price of a Haircut

Greek citizens delivered a resounding ‘No’ to bailout conditions demanded by creditors in a referendum held on 5th July. The government-backed ‘No’ side won with 61.31 percent of votes but does this mean Greece will eventually abandon the euro? Not exactly. The referendum was essentially over the bailout agreement with the country’s creditors rather than on membership in the Eurozone. AsPrime Minister Alexis Tsipras pointed out, “This is not a mandate of rupture with Europe, but a mandate that bolsters our negotiating strength to achieve a viable deal.”

Undoubtedly, the landslide victory in the referendum has greatly strengthened the bargaining power of the current government with creditors. Now the ball is in the court of the Greek government to extract a better deal with substantial debt relief and less punishing austerity measures.

Debt relief remains a bone of contention between Athens and Brussels. In the last six months, concrete proposals put forward by the SYRIZA-led government seeking a debt ‘haircut’ were outrightly rejected by European creditors led by Germany. On its part, the Greek government has opposed painful austerity measures demanded by the creditors.

Within hours of the referendum result Greek Finance Minister Yanis Varoufakis, announced his resignation, hinting at pressure exerted by European leaders against his presence in the negotiations. To placate the European creditors, the government accepted his resignation and appointed Euclid Tsakalotos as the new finance minister. But the Troika appears unrelenting.

A New Deal for Greece? 

In the present circumstances, a new bailout deal is challenging but still feasible. To end the impasse, both sides need to realize the sense of urgency to pursue a realistic agenda. To avoid a major financial meltdown in Greece which would also have grave consequences for the rest of Europe, the European leaders should adopt a more flexible attitude and accept the verdict of Sunday’s referendum. The referendum’s message is loud and clear: the harsh austerity measures demanded by the EU lack democratic legitimacy. And debt relief should no longer be treated as a taboo. Hence, keeping the wider objectives of the European project in mind, its political leadership should rather welcome the people’s verdict and resume negotiations with Athens immediately.

Unfortunately, Germany is still continuing with its hardline approach towards Greece on debt relief. This, despite the fact that six decades ago, Germany’s creditors (including Greece) had written off more than half of country’s foreign debt at the London conference in 1953.

It is important to note that the IMF in its preliminary draft debt sustainability analysis (dated June 26, 2015) has sought substantial debt reduction along with extended concessional financing for Greece.  This IMF analysis specifically points out that Greece needs “a significant haircut of debt, for instance, full write-off of the stock outstanding in the GLF facility (€53.1 billion) or any other similar operation.” The Greek Loan Facility (GLF) consists of bilateral loans pooled by the European Commission.

It remains to be seen whether the IMF Board will support substantial debt write-off for Greece (as emphasized in the analysis). If the IMF takes a more sympathetic view of Greece’s debt burden in the official negotiations, it could encourage Germany to enter into debt relief discussions.

As the previous bailout agreement has been firmly rejected by its citizens, the Greek government should put forward a new proposal consisting of substantial debt relief and less austerity. A new framework agreement with creditors could be worked out immediately as the detailed action plan could take weeks or months to reach an agreement.  On their part, European leaders should stop arguing any special privileges to Greece would encourage other potential rule-breaking eurozone countries. After all, financial rules are meant to serve the people, not the other way around.

The outcome of several meetings planned by Eurozone finance ministers and political leaders this week will provide the roadmap of future negotiations with Greece. In the next few days, an agreement on the refinancing of Greece’s fragile banking system is badly needed. The political leaders should direct the European Central Bank (ECB) to provide liquidity support to the Greek banks, without which they could collapse.

In two-weeks’ time, Greece will have to repay €3.5bn on July 20 on a bond held by the ECB. Last week, Greece defaulted on a €1.5bn repayment to the IMF and therefore cannot receive new money until the country clears all arrears to the Fund in full. In the absence of any liquidity support from the ECB, Greece is likely to issue IOUs (I owe you) which could pave the way for a Grexit.

Two Possible Scenarios 

There are two possible scenarios that stand out at this critical juncture. First, a new deal is potentially feasible if both sides show patience and flexibility to reach an agreement. On its part, Greece should also undertake policy measures to check massive tax evasion by oligarchs and streamline its public finances. Needless to say, the Greek government should be given a fair chance to put its house in order. This entails patience on the part of official creditors.

The second scenario revolves around a Grexit. The prolonged stalemate may lead to a collapse of Greek banking system and more defaults in the coming weeks, thereby increasing the chances of Greece leaving the Eurozone.

Kavaljit Singh is Director of Madhyam, a policy research institute based in New Delhi