From Greferendum To Grexit?

Referendum unlikely to solve the Greek crisis.

I’m sure many are hoping the Greek crisis will come to a swift end after Sunday’s referendum, with a Yes vote leading to a new deal with the creditors and a return to normality and a No vote leading to a quick exit from the euro.

Alas, it is not likely to be as simple as this. I don’t see a quick resolution to the crisis after either a Yes or a No vote. Indeed, despite the apparent historic significance of the referendum, I suspect we may end up in a similar position in a few months time no matter how the vote goes.

What Happens After a No Vote?

A No vote may send Alexis Tsipras back to Brussels even more sure that he has a mandate to negotiate a better deal with the creditors. Greece’s creditors, however, will still argue they have their own mandates and that the referendum changes little for them. So further stalemate is the most likely near-term outcome of a No vote.

Will a No lead to a quick exit from the euro? I don’t think so but it will keep the banking restrictions in place and this may eventually lead to Greece leaving the euro.

Cash Crisis

Last week, I pointed out that Cyprus’s economy survived relatively well in 2013 after banking restrictions were imposed. However, it is becoming clear that the banking restrictions in place in Greece are more severe and are having a substantial disruptive effect on the economy.

This probably means there is less time available for further negotiations before the Greek government has to consider taking the first steps towards issuing its own currency. One step it could take is to begin issuing IOUs to pay pensioners and welfare recipients — these would be a promise to pay the holder of the IOU a certain amount of euros at a later date. It could also announce that these IOUs could be used to pay taxes.

If the crisis continues for long enough, these IOUs could become a parallel currency with a possible endgame involving the conversion of all bank accounts in Greece into the new IOU currency (i.e. the drachma). The Greek government or the Bank of Greece could then supply as much new currency liquidity to these banks as they require. Restrictions on withdrawals of the new currency could be lifted but strict controls on moving euros out of the country would remain in place. Quite possibly, the Greek government could maintain that they had not left the euro but were merely taking the necessary steps to keep their economy afloat. In reality, a Grexit would have occurred.

What Happens After a Yes Vote?

A Yes vote probably presents an even more complex scenario. One possibility is the government calls new elections. This would prolong the uncertainty and keep the banks frozen until a new government was elected and negotiated a new deal.

Another possibility is that that Tsipras returns to the negotiating table claiming that he is now willing to accept all of the conditions in the previous offer from the creditors but perhaps adding the qualification that he will only sign the deal if the creditors agree to significant debt restructuring.

Technically, a Yes vote relates to accepting an offer from Greece’s creditors that was tabled prior to the end of a programme that expired on June 30. This means negotiations of some sort are required even if there is a Yes vote. However, there would be no goodwill on either side. Tsipras would be negotiating to obtain a package he had campaigned against. The creditors would not trust Syriza to implement the package and would perhaps prefer the talks to fail in the hope of triggering new elections and a change of government.

So a Yes vote seems likely to lead to a new election. While it would be best if such an election happened swiftly, it may not arrive for some time.

What Would Happen After Elections?

Even if a new election results in a more conciliatory government (e.g. a return of New Democracy) it will take time to negotiate a new programme. Then this programme would have to be approved by European parliaments and only after funding is restored would you see the ECB removing the cap on emergency funding for the Greek banks. Indeed, given the damage done, the ECB may insist on a new round of recapitalisation for the Greek banks as a condition for resuming lending and this could complicate the negotiation of a new package.

Even with a new programme in place, the reputational damage the crisis has done to the Greek banking system may be such that banking restrictions could remain in place for years even if the ECB continued to provide large amounts of credit to the system.

And this assumes that new Greek elections result in a regime change. My guess, however, is that Syriza (or some patched-up version of a left-wing alliance) would win any election that took place after a Yes vote. Even if 60% of the Greek public vote Yes, these votes would then be spread across a wide range of different parties in a general election while Syriza would likely get the support of the vast majority of the 40% that voted No. Because the Greek parliamentary system gives a large seat bonus to the biggest party, Syriza could easily win an election after losing the referendum.

Most likely, a new Syriza-led government would again act as though it has the mandate to turn down the kind of offers currently on the table. In other words, a few months down the road after a Yes vote, we could be back where we would be after a No vote.

What Can The Creditors Do?

I hope I’m wrong about all of this and that the crisis can be resolved in the next few weeks. However, if the process drags on and heads towards a Grexit, it will do substantial damage to the European Union, both economically and diplomatically.

One thing Greece’s creditors can do to help resolve the crisis as speedily as possible is to offer significant debt relief. With the IMF’s Debt Sustainability Analysis now publicly available, the economic case for providing such relief is beyond doubt. Tangible debt relief will provide exactly the “win” that any Greek government will need to persuade the Greek public that it is worthwhile signing a deal that requires years of primary surpluses to pay back its debts.

The alternative approach — pushing Greece towards a euro exit — is probably the strategy that will ultimately minimise the return of money to its creditors. The moral and economic case for debt relief is there. Now it just requires the political courage of Europe’s leaders to admit their past mistakes and stop pretending Greece is going to pay back all the money.