The Waiting Game
Despite a flurry of Anglophone media reports suggesting that the results of the latest regional election in the Spanish region of Catalunya has increased the likelihood of a vote on secession, public opinion in Spain itself seems to be unfazed by the electoral outcome. In fact, the hurdles for a referendum are far from cleared and remain almost insurmountable. The Spanish media describe the test as a largely positive one for the embattled Prime Minister Mariano Rajoy. He has now cleared two political obstacles: the regional elections in his home region, Galicia, a few weeks ago, and in Catalunya this past weekend. Rajoy has enough political maneuvering room to request a bailout from Spain’s European partners (through the European Stability Mechanism, the ESM), thus potentially activating the bond buying program of the European Central Bank should he choose to do so. Fortunately for Rajoy, market pressure has evaporated, which is allowing him to bide his time. A decision on the bailout request now hinges on a deal regarding Europe’s banking union, which, if agreed, should finally clarify when and how Spanish banks can be recapitalized directly by the ESM. As long as negotiations on the banking union continue, Madrid will likely continue to wait.
He is not the only one waiting. European leaders have postponed a decision on the European Union budget for 2014-2020. Markets have remained quiet. They were waiting too − largely on a decision on Greece, which once again is running out of cash. Courageously, the International Monetary Fund has decided to lift the smokescreen surrounding the country, which has been stuck in a steep recession since 2008. The IMF’s managing Director, Christine Lagarde, has decided (probably in some measure a result of pressure from some of its biggest stakeholders) that kicking the Greek can down the road past the German elections is not only too high a price to pay for Greece, it would also seriously jeopardize the credibility of the fund. It is time for European governments and institutions to take losses on their holdings of Greek debt, she argues. Lagarde is appealing to European governments to act with courage and finally tell their voters what is really needed to save the small Mediterranean country. Unless they do so, Greece will continue to gravitate in a downward spiral, unable to lift its debt burden and with no possibility of growth. Mme. Lagarde has a point.
Official creditors, European politicians, and Germans in particular, have resisted the IMF’s calls for action, citing among other things the no bailout clause, which prohibits euro zone nations from bailing each other out, and the dangerous precedent that such a step would set for other euro zone countries currently receiving financial help. In fact, if partial defaults are allowed to take place within the euro zone, Germany will lose her bargaining power and be stuck with the final bill. The political cost could become too big to bear, not only for the German Chancellor Angela Merkel (who would probably lose the election), but also for the euro zone as a whole (which could indeed loose all its political support within Germany).
Does that mean that the euro zone has to choose between a Greece condemned to be on life support for years or Germany’s continued support for the euro? Not necessarily.
In fact, even the German government realizes that Greece needs bolder action to heal. A haircut for the official sector is not something Berlin will be able to resist forever. However, timing matters. And it is not only her own electoral timetable that is holding Merkel back.
One reason for the stall is Greece itself, which has shown how quickly decisions taken by its parliament can be undone when the time comes to implement them. Merkel gives the Greek Prime Minister Antonis Samaras the benefit of the doubt. However, only time will tell whether he can deliver on his promises. According to German government officials, the political elite in Athens has only recently realized how serious the situation is. Greece is now inching closer to a primary budget surplus. Once Greece meets this goal, its government would not only demonstrate that it can fund itself with its tax revenues (were it not for the huge stockpile of debt that needs to be serviced), it would also be in a far stronger negotiating position. The question of a debt write-down would reemerge more strongly than ever before.
Merkel is conscious of the fact that time could further weaken her bargaining position. Before decisively giving in on Greece, she needs Europe to move closer to a fiscal union, in order to better control what short cuts other euro zone governments might be tempted to take to reduce their own debt stock. Some readers might argue that a fiscal union is years off, and that Greece cannot afford to wait for very much longer. Although a valid objection, this is only partly true. Several institutional tools, which are designed to better control member states’ budgets have already been passed by euro zone countries, are now just waiting to be fully implemented (They bear somewhat obscure names such as European semester, six-pack, fiscal compact) . In fact, the framework for a fiscal union, albeit not yet a very precise one, already exists, and it is being kept below the radar screen of domestic public opinions by politicians weary of adverse reactions from their respective constituencies.
For these reasons, Greece’s problems should not be seen in isolation. They are still part of a larger European web.
The continent will no doubt face a few more moments of truth. Whether the current situation is a sign of careful engineering by European leaders designed to allow all of the moving parts to fit a grand design or whether we are only experiencing a new bout of complacency is hard to tell. For now, all financial markets and interested observers can do is to join in and sit out the waiting game.