Regardless of decision on early elections, political uncertainty is now a market issue

The prospect of early general elections raised by Prime Minister George Papandreou in a country depending on eurozone countries and the International Monetary Fund to finance its borrowing needs will have an adverse impact on local assets and the economy for quite some time, regardless of the Premier’s final decision. There is no question that most foreign analysts and others are perplexed by Papandreou’s decision to link the outcome of local elections with the possibility of calling early national elections. After all, they are not used to hearing the leader of a government with a comfortable majority in parliament talking – and even more so calling – early elections when his country is striving to implement a series of structural reforms and achieve fiscal consolidation in order to get the necessary funds to pay salaries and pensions in the public sector and service its public debt. To any outsider who is not well versed in Greek politics, this is like somebody shooting himself in the foot. This is so because one has made an effort to be consistent and convince his partners that the country is back on the right track and committed to following stable policies but choosing midway to undermine this course by instilling a degree of political instability. This also is not what one would expect from a country that is nearly bankrupt, in the sense it cannot access international markets to raise the funds needed to cover its needs. After all,as some foreigners point out, one of the reasons the IMF and the eurozone agreed to setting up the 110-billion-euro mechanism to fund Greece was the relatively recent election of a strong government. Perhaps Greece’s official creditors, dubbed the troika, are the only ones who could weigh on the decision to call early parliamentary elections. Of course, none of them would like to interfere with local politics and go against the will of an elected government. However, they could have influenced the decision by making it clear they will be tougher with the country’s satisfying the terms and conditions set out in the economic plan. Even more importantly, they could have raised the prospect of withholding approval on extending the maturity of the loans provided to Greece for a longer period. According to the present agreement, each quarterly disbursement is to be fully repaid in five years. On the other hand, there is no question that the economic situation in Greece is likely to worsen in coming months and the ruling political party will bear the brunt of popular discontent. So, from the partisan political point of view, it may pay to hold early elections now that the ruling socialists are likely to win again, rather than wait for later, or even commit political suicide by going for the entire four-year term. It was not clear whether Papandreou would call early general elections when these lines were written. It was clear though, that on the one hand, he had painted himself into a corner, and on the other, that he would not win even if he decided not to call early elections. The reasons are very simple. If he called early general elections in a month or so, the spreads on Greek bonds over Germany would widen even further and the Athens stock market would take a fresh hit. A month may be a short time measured in calendar days but it is a long time from the markets’ point of view, as they tend to move fast to discount the impact of such political events. Greek bankers do not rule out the possibility that a good deal of deposits will be withdrawn from local banks, either to be held at home or sent abroad, seeking more safety in a situation of political uncertainty. The extent of outflows, if it indeed materializes, will put more pressure on the local banking system and this will be felt soon in the rest of the economy. Greece has already experienced large deposit outflows, estimated at 20 billion euros or more since the start of the year. Deposits of local households and firms stood at about 213 billion euros at the end of September from 238 billion euros at the end of 2009. Still, the prospect of early general elections will not be forgotten by market participants, even if Papandreou decides not to call early national elections. After a relief rally in bonds and stocks, the market will try to find a way to price the likelihood of calling early elections later, penalizing them accordingly. Unfortunately, the Greek political risk is no longer considered immaterial. Of course, there should be no sizeable deposit outflows in this case – and this is positive. However, people will definitely be more sensitive to political and economic developments after a pause of a few months. So, regardless of the Prime Minister’s call, Greek assets will not benefit from the higher political risk. Of course, the negative impact will be bigger, highlighted by a likely withdrawal of deposits, if early elections are indeed called.