Government too conscious of its image

Negotiations with Greece’s lenders may have picked up pace recently but an interim agreement does not seem feasible at this time. Therefore, the SYRIZA-led government will have to make some tough decisions until the next Eurogroup on May 11. It is hard to guess what Prime Minister Alexis Tsipras will finally do but a compromise, even a politically painful one, is better than the alternative.

Time is not on Greece’s side. Its negotiating position is weakening as the general government’s cash buffers are running out and the economy is suffering. Of course, the country has surprised many by its capacity to fully meet its internal and external obligations even though it has not received any official sector loans and has been shut out from the markets since August 2014. It has been able to do so by borrowing a good deal of cash reserves from state entities and social security funds via short-term repo operations and rebuilding arrears to the private sector. This would not have worked if the ECB had not allowed Greek banks to replace deposit outflows from state entities with ELA (Emergency Liquidity Assistance) loans.

Pundits claim that the main reasons behind the inability to conclude the review of the bailout program, as redefined at the February 20 Eurogroup meeting, have been disagreements about reforms and the fiscal gap in 2015, among other issues. The lack of proper communication also played a role, creating visible frustration among the creditors’ ranks. Political marketing may have played a role as well, since it would have been harder to convince the public that the administration was taking a tough negotiating stance if a deal were struck early on, pundits say. However, disagreements over structural reforms and communication issues were, in our opinion, the dominant factors.

Hopes for an agreement in principle resurfaced last week, following a reshuffle of the Greek negotiating team, with market participants driving bond yields sharply lower. Since then, both sides have alluded to a better climate and the creditors admit there has been an improvement in the negotiating process. Moreover, it looks as if senior cabinet members, like Deputy Prime Minister Yiannis Dragasakis, have understood, judging from recent statements, that Greece cannot count on a political decision to break the impasse without a staff-level agreement. For quite some time, a number of government officials thought a political solution at the top level was possible, underestimating the importance of not bending the rules, at least most of them, in the European Union.

We argued a few weeks ago that the Greek side should water down its position on some key reform areas, like pensions, and the lenders should have accepted in return an agreement, moving one or two thorny issues to the new round of talks, expected to be concluded in June. Some financing should have been provided until then, not necessarily in the form of EFSF/ESM loans or the ECB allowing local banks to buy more treasury bills, but perhaps via the disbursement of EU structural funds. The latter could turn into a source of short-term state funding. Of course, one may ask why the leftist government would make concessions on the same issues in June if it does not make them now. The answer is because the new deal would hopefully include some debt relief measures and pro-growth EU-funded investments, making it easier for the government to sell it to the public.

However, judging from various statements by high-level EU officials, the piecemeal approach is not on the table. The lenders appear adamant that the Greek side should present a full list of reforms for evaluation and for the ongoing review of the bailout program to be concluded. In this regard, the government is facing a dilemma since some of the reforms cross its so-called “red lines.” However, recent difficulties with the payment of some pensions highlight the fragility of public finances and the risks to the government’s popularity if the ongoing negotiations fail.

Of course, Tsipras left open the possibility of a referendum on a possible deal in his last television interview and some see it as a democratic way out of the stalemate. However, the majority of the population seems to be against such a step, according to opinion polls. Moreover, bankers warn that there is a high risk of capital controls being imposed in the days or weeks leading to a referendum. On the other hand, this could boost the majority, backing even a painful deal to keep the country in the euro but could do damage to the economy and undermine the government.

Undoubtedly, these are not easy decisions and could have been avoided if there was more focus on the outcome of the negotiations and less on how the public perceived the way the Greek side negotiated with the lenders. Although the government has until the end of May or beginning of June to strike a deal with the official lenders, crunch time could come earlier. Perhaps before May 12 when Greece is due to make a payment of around 747 million euros to the IMF. Let’s hope it chooses a compromise, even a painful one, with the lenders over the alternative.

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