A deal is needed before problems grow

The newly-elected Greek government has managed to infuriate some of its eurozone partners with its defiant stance on the EU/IMF bailout, but has also won over the hearts of the vast majority of Greeks, according to opinion polls. If certain government officials are right, there will be an agreement in principle at Monday’s Eurogroup, providing respite to the economy and vindicating the government’s tough tactics. Even so, the country’s economic problems cannot be wished away.

The SYRIZA-Independent Greeks (ANEL) government was elected on a political agenda comprising two major actions: First, terminating the austerity policies pursued by previous governments, ending the bailout program and doing away with troika intermediaries. Second, seeking a sizeable debt reduction via writeoffs. It is difficult for the government to back down from these two objectives for obvious reasons, the foremost being that it could jeopardize its unity since the ultra-leftist wing of SYRIZA and rightist ANEL would object. Moreover, it would also disappoint the high expectations of the public.

The government has made it clear it wants to engage in political-level negotiations on these and other matters, seeking a bridge loan agreement until the final “contract” is agreed upon. On the other hand, the Eurogroup – and Germany along with some other countries – insist on completing the final review of the current bailout under the supervision of the troika, the representatives of the official lenders. However, they have been open to another form of monitoring to accommodate the Greek government’s demand to end the troika mediation be finished.

Facing staunch opposition from other eurozone countries, the government seems to have backed down from its original version of debt relief, namely a haircut on the nominal value of debt. Instead, it has indicated its willingness to accept a reduction in NPV (Net Present Value) terms by extending loan maturities and cutting interest rates. However, it appears determined to lower the required primary budget surplus and resist or even roll back some structural reforms in the labor market, privatization and pension reforms. At the same time, it wants to speed up others to collect more revenues and take some “oligarchs” to task.

But the big question for the time being is whether the government can strike a deal at the Eurogroup meeting on Monday. The signs from high-level EU officials, like Commission President Jean-Claude Juncker, are not encouraging. However, the signs from the Greek government are more promising. A government source said on Friday that “a strategic agreement on the targets” was likely at the Eurogroup meeting but the “business plan with the details and the numbers will be worked on in the next few months.” It remains to be seen whether this is the case, although some drama cannot be ruled out, taking the deal down to the wire – to February 28. This could be the case if a legal formula has been found to clinch the deal without the approval of national parliaments.

If the source is right, the government’s tough stance toward the lenders and Germany in particular will be vindicated, making the previous Greek coalition government and others in europeriphery countries look bad in the eyes of their people. Emotions are already running high with some conservative operatives ready to even call their party leaders “traitors” for their soft stance if the prime minister gets a good deal.

Some analysts argue that this government, unlike its predecessor, takes history and geopolitics into account when negotiating with the EU, and Germany in particular. According to them, the Germans are strong economically but weak in imposing their will as this could revive the image of aggressor they want to shed. In their view, the Germans may want to punish the Greek government for its defiant stance but know it has been elected to resist the bailout program. In this respect, the German government has no option but to reach a compromise because Greece could default and this could undermine the euro project and the free trade area, both central to Germany’s prosperity. One cannot rule out the possibility that default may turn out to be beneficial for Greece in the medium-term, encouraging others to follow suit, they say. This view contrasts with economic orthodoxy.

Of course, time will tell whether the tough negotiating tactics of the new government will bear fruit or not. In the meantime, economic reality will hit home if the stand-off persists as uncertainty adversely affects activity, undermining the prospects for stronger GDP growth. Already, preliminary data showed that GDP declined in the last quarter of 2014 compared to the previous one although activity for the year was bigger than expected at 0.82 percent. Pundits say many transactions and investments are frozen and even tourism looks potentially vulnerable despite last year’s positive momentum. Imports and exports could be hurt if the impasse continues, as Greek bank credit letters are not accepted abroad.

The ECB’s decision to lift the limit for ELA loans to local banks helped avert the imposition of ceilings on cash withdrawals, but credit to the economy continues to shrink. In addition, the fiscal revenues missed the target in January by a wide margin, raising doubts about the execution of the budget. All these signals from the economy should be ringing alarm bells in the domestic political establishment and abroad as they are bound to have social and political repercussions down the line. A compromise at the Eurogroup meeting on Monday or in the days ahead is key.