Foreign Emerging

Greek Accord: A Defining Moment, But Not the End of the Story

July 14th, 2015 | By Nick Sargen

Highlights

  • Markets have rallied on news of a last-minute accord between Greece and its creditors, which lessens the risk of a "Grexit." A key difference from previous negotiations is the requirement that the Greek government must pass mandated legislation by July 15 to be eligible for a new bailout package.
  • This requirement, if enacted, would lessen the risk of back-peddling by Greece, and it also sets an important precedent for other countries that encounter debt problems. That said, it's questionable whether the latest package will prove successful in transforming Greece's economy.
  • The negotiations are a defining moment for the eurozone, as it marked the first time a member country was nearly expelled. As such, it sets an important precedent for other members, and it remains to be seen whether it has permanently altered the eurozone.
  • Amid these developments we have not altered our investment strategy, as we expect the fallout from Greece's problems to be limited.

Greek Drama: Down to the Wire (again)

For fans of video thrillers or Greek tragedies, it's hard to imagine a script that contains more twists and turns (including a surprise ending) than the negotiations between Greece and its creditors. Just a few weeks ago, the creditors were willing to make concessions to the Greek government on a bail-out package that would enable it to service its pending debt obligations. Instead, President Tsipras lambasted the offer and called for a referendum to demonstrate the public support it had to negotiate more favorable terms.

This action proved to be a gross miscalculation, as it infuriated the creditors and made them more determined to dictate the terms for Greece to stay in the eurozone. The latest terms not only were much tougher than the original ones, but they also required the Greek government to enact the mandated reforms within 72 hours to be eligible for a new bailout package.

In doing so, Angela Merkel maintained that while she wanted to keep Greece in the eurozone, she would not do so at any price, and Germany's Finance Minister put forth a proposal whereby Greece could exit the eurozone temporarily if it failed to pass the required legislation. According to press reports, negotiations between Germany and Greece nearly broke down over a proposal to place Greece's most valuable assets into a €50 billion privatization fund managed by the EU. Marcus Walker of the Wall Street Journal summarized the significance of these developments as follows: "Sunday's statement on Greece by eurozone finance ministers will go down as one of the most brutal diplomatic demarches in the history of the European Union, a bloc built to foster peace and harmony that is now threatening one of its own with ruination unless it surrenders." (WSJ, July 13, 2015)

The tough stance taken by the creditors should have two positive effects. First, it lessens the risk of back-peddling by the Greek government. Second, it lessens the risk of other member countries following Greece's example. From this perspective, some observers contend the prospects for the eurozone have been strengthened, because the price of exiting has been shown to be very steep.

At the same time, the question remains whether Greece will be able to service its debt in the future assuming it adheres to the latest program. While Greece needs to embark on structural reforms of labor laws and the pension system to make it competitive within the eurozone, the accompanying fiscal measures will weaken the economy in the near-term when it already is in the grip of recession and the banking system is barely functioning. Therefore, I am skeptical that the latest package represents a lasting solution to Greece's problems.


Investment Implications

Amid this drama, we have not altered our investment strategy, mainly because we anticipated a last minute agreement and also felt that the fallout from a "Grexit" could be contained. First, from a pure mathematical standpoint, Greece's economy is too small to have a material impact on the U.S. or other major world economies. Secondly, on the financial side, the potential contagion due to defaults on Greek debt appear relatively small and manageable. Furthermore, the ECB now has tools to manage through a Grexit scenario, and unlike 2010-2012, Greek debt is now held mostly by public institutions that will not be forced to sell other assets to reduce risk.

In the end, we believe the main impact the Greek crisis will have is on investor confidence. Throughout the twists and turns of the negotiations, investors responded favorably whenever it appeared Greece would stay in the eurozone and negatively when the risk of a Grexit increased. The principal reason is the prospect of a Greek exit raised the specter that political developments in countries such as Portugal, Spain, and Italy could increase the risk of additional exits from the eurozone. However, in the wake of the decisive manner in which the EU leadership acted, such concerns are likely to lessen. Therefore, we believe investor attention is now likely to shift away from Europe and back to developments in the U.S. and other regions.