ECONOMICS: EUROPEAN PERSPECTIVES—OCTOBER 17, 2014

Early Exit and Elections in ?

Dennis Shen Economic Associate—Global Economic Research, + 44 (020) 7173 9270 Darren Williams Senior European Economist—Global Economic Research, + 44 (020) 7959 4543

Recent concerns over Greece’s bailout exit and possible early Display 1 elections have led to a sell-off in Greek sovereign bonds. In our A Sell-Off in Greece 10-Year Bond Yield, Greece and view, Greece will most likely be forced to stay under at least a Portugal 9 precautionary program from the EU. Moreover, the prospect of Greece 8 Portugal an early election raises spillover risk to other peripheral markets. 7 6

The Greek government and the “troika” of Greece pushes for an exit from the bailout, Percent 5 the , European the more markets show skepticism and 4 Central Bank and International Monetary close the very market access Greece needs 3 Fund (IMF) are currently negotiating how for this plan to succeed. 2

Greece will exit (or transition from) its 2014 financial assistance program when it Greek Bond Yields Spike As of October 17, 2014 concludes at year-end. How this transition Rising uncertainty around Greece’s financing Source: Reuters is designed will have huge implications for and political outlook, alongside the recent the medium-term policy environment. In escalation of concerns about global growth, bailout, including a request for an early exit addition, these negotiations come at a has contributed to a major sell-off of Greek from IMF assistance. difficult time, with a growing chance that government bonds. The yield on the 10-year the inability to elect a new president could bond has risen sharply to 8.0%, from lows Under the current bailout, Greece’s trigger an early parliamentary election next of 5.6% in early September (Display 1). In European Union (EU) loans (and the formal year. our view, higher Greek yields and increased troika program) conclude at the end of volatility are likely to be the norm for the 2014, but its IMF program continues The bailout exit and early elections are near term. Moreover, current yields mean through early 2016. To resolve the gap intricately linked. A clean exit from the the potential for spillover from Greece to between the two programs—and to exit financial assistance program and an end to other peripheral markets has increased— the memorandum in full—Greece has the associated conditionality would give a particularly if an early Greek election proposed an early termination of its IMF big boost to the government and reduce becomes more likely alongside any program (and withdrawal from the last the risks of an early election. If Greece intensification of global risk aversion. €12.4 billion in IMF loans set for 2015 and can’t exit its bailout, early elections are 2016). This would let Greece exit both almost inevitable. Focus on an Early Exit lending facilities at the end of this year, When the troika review resumes in early which could be presented as a political Meanwhile, Greece and the markets are November, the market’s attention will victory back home and a clear step locked in a vicious circle. The harder that center on negotiations around Greece’s towards Greece shaping its own future. Can Greece Exit? candidate, it must be dissolved and new But is this really possible? This will depend elections called. Opposition parties can use Display 2 on Greece’s ability to meet its financing this as an opportunity to block the A Financing Gap of €13.5 Billion needs through private means. We estimate presidential candidate, and force early Financing Requirements by Source of Financing that, if Greece opts out of the remaining parliamentary elections. That’s precisely IMF loans, it would have a financing gap what’s happening now. 120 100 of about €13.5 billion for 2015 to early 80 2016 (Display 2). Several opposition groups, led by the 60

Coalition of the Radical Left (), have Bil. Euros 40 Although Greece is “fully comfortable” committed to blocking the government’s 20 that it can meet this financing need presidential nominee—on the expectation 0 (20) without assistance, the EU and IMF are that an early parliamentary election 10 11 12 13 14e 15e 16e much less confident. And, based on the would strengthen their own positions. Financing Gap* Bond Issuance Other Resources** Official Loans recent sell-off in Greek bonds, there are Syriza currently leads in the opinion polls, Total † still significant doubts in financial markets with about 30%–35% of voting inten- about supporting Greece without troika tions (roughly 10 points more than the *Financing gap is the residual need after assuming €10 billion is drawn from cash (out of a bank recapitalization facility) in 2015, involvement and against a backdrop of a ruling party, ). With this and assuming the withdrawal from the remaining IMF loans. **Includes the drawdown of cash. deteriorating Greek political environment. share of votes, an early election would †The 2012 funding requirements are elevated owing to the PSI give Syriza nearly half the seats, and sweetener and bank recapitalizations. Source: IMF, European Commission and AllianceBernstein In our view, with market access now in almost certainly bring in a government question, Greece will most likely be forced under its leadership. to sign up to a new support line from the Currently, this looks like a big challenge. EU. What form it takes won’t be decided Financial markets and European political The government has had little success in until late this year. Owing to its preference leaders are very uneasy about this rallying others to its cause. Several for European support over the IMF, Greece prospect. Syriza, with its traditional opposition parties have already pledged to has recently indicated that it is willing to anti-establishment approach, is likely to vote against any presidential candidate the negotiate a precautionary credit line from escalate the confrontation with Greece’s government nominates. And a failure to the EU (and maintain plans to forgo the IMF official lenders to new levels. In the past, fully exit the bailout will further undermine loans). This is probably the minimum that’s the party has taken a hardline stance potential support. needed now, to provide a safety net in case against austerity measures and supported Greece runs into funding difficulties next a much more material renegotiation of the Of course, these positions may change as year. The risk is that a third formal bailout government’s troika loans, including debt the threat of early elections loom. Some facility from the EU may be required (to write-offs. While Syriza is committed to groups that are against the government remove Greece’s need to access markets staying in the euro area, and has moved to may be even more against a Syriza altogether), but policymakers in Greece will a more centrist position in recent years, the alternative. Moreover, recent polls have resist this option for now owing to the risk of a split with the troika and abrupt suggested that the majority of heavy political costs that it would entail. changes in policy are still material concerns don’t want an early national vote. if the party comes to power. A Presidential Obstacle Still, in our base case, we now anticipate The current bailout negotiations have taken Chance for an Early Election an early parliamentary election to be held place in the context of a very uncertain The question then is: Can early elections next year. If so, this will maintain selling political environment, created by the risk of be avoided? pressure on Greek bonds for the near an early parliamentary election. The early term. At the current levels, we are election risk is the result of a way in which At present, the Greek government has 155 monitoring closely the potential for Greece’s president is elected. seats in the 300 seat parliament. For a spillover from Greek risks to other three-fifths majority, the government needs peripheral markets. While in recent years Every five years, the Greek president is 180 votes* for its candidate in next there has been greater differentiation by elected by members of parliament (MPs), February’s presidential election in order to investors between Greece and the rest of rather than through a direct popular vote. prevent early parliamentary elections. That the periphery, the threat of an early If parliament cannot muster a three-fifths means it needs to find 25 votes from election could reintroduce a degree of majority to support a presidential opposition groups. contagion. n

*This threshold may be modestly lower at 175 votes for a 3/5th majority next February—if nine MPs from the party, , remain in detention on charges.

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OCTOBER 17, 2014 ECONOMIC PERSPECTIVES