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There is scope for a deal on Greek debt

The Greek government and its creditors have strong incentives to reach an agreement – and have scope to find a mutually beneficial solutions. Negotiations will be difficult - temporary setbacks could cause bouts of market volatility over the next few months, but these may turn out to be buying opportunities if a deal is eventually done...

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The result of the Greek elections was broadly in line with expectations, with Syriza’s 149 seats just shy of the 151 needed to govern alone. With the support of the anti-bailout party Independent Greeks, Syriza is able to form a government and has a strong mandate to pursue its policies.

The initial market reaction was negative - some investors may have hoped to see centrist Potami as a coalition partner rather than Independent Greeks.

Ignore the noise - focus on the end result

Over the coming months, we can expect a series of difficult negotiations surrounding the Greek public finances. This process will likely generate a lot of noise and volatility, and its course will be very difficult to predict on a day-to-day basis – so in my view it is best to try and focus on how things will look in the second half of the year, once the dust has settled.

The most plausible outcome in my view is that the Greek government and its international creditors reach an agreement under which the net present value of Greek debt is reduced to a more bearable level via interest rate cuts and maturity extensions, in exchange for promises to run some kind of primary budget surplus, albeit smaller than the 3% of GDP previously envisaged.

While Syriza might like to see Greece’s official creditors take a larger haircut, the reality is that north European taxpayers appear unlikely to stomach a reduction in the nominal value of the Greek debt – not least because of the potential read-across for other indebted countries whose debts are so large that nobody could afford to write them down.

Hard bargaining

In the short term, we could see a temporary impasse – with Syriza demanding more debt forgiveness than creditors are willing to grant. The Greek government will need to demonstrate to its voters that it has tried to get the best possible deal.

However, a protracted standoff could affect government revenues, encourage capital flight and send growth back into reverse – which would prevent the government from delivering on the promises it made to voters, the vast majority of whom want to stay within the Euro area.

Greece is turning a corner….why derail the recovery?

Consequently, I believe the Greek government has strong incentives to avoid a head-on collision with rest of the Eurozone and there is scope to find a compromise. After years of contraction, the Greek economy bottomed out last year and grew 1.9% in the third quarter. Provided there are no further shocks to confidence, and no incremental austerity, Greece has the potential to enjoy a cyclical recovery that would make it easier to achieve both fiscal and social goals.

In the same way, Greece’s creditors have an interest in maximising their recovery on Greek debt, and a certain amount of realism and flexibility on the timing of repayments may well prove more effective in this respect than a rigid defence of the payment schedule.

Might the creditor nations refuse to budge, and allow a Greece financial collapse ‘pour encourager les autres’? It is not impossible, but this would not be cost-free path for creditors to take. The resulting upheaval would cause collateral damage outside Greece, increase the scale of losses on debt, and waste the political capital that has been spent on keeping Greece within the Eurozone – and these considerations could encourage creditors to seek compromise.

None of the players in this poker game have particularly good cards – so it would be wise for everyone to refrain from upping the ante too far.

There is scope for a deal to be done if politicians can avoid mistakes. Until we see evidence of positions converging, we expect bouts of volatility in Greek stocks. These may prove to be significant buying opportunities for us in the event that an agreement is eventually reached.

Colin Croft , February 2015

Article also available in : English EN | français FR

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