“Quack!” Grexit, Stage(d by the) Left

The curtain is about to fall on the tragicomedy that has constituted Greece’s five-month-long negotiations with its creditors. And it’s a real cliffhanger. The hero of the piece, a would-be messiah with the manner of a demagogue, having led his people to the very brink of the abyss, suddenly turns to ask for their blessing as he guides them over the edge. Suicide by Democracy.

Tspiras’ call for a referendum has clearly caused surprise and consternation amongst Greece’s European partners and, given the strongly positive market reaction early last week when it looked like rapprochement might be possible, is likely to provoke surprise and consternation when financial markets open on Monday.

I find myself somewhat surprised at the surprise with which this development has been greeted. Throughout this series of posts on the Greek saga (for example, my first post ‘Grexit or Grin‘, and more recently ‘The Greek Tragedy Unfolds…‘), I have consistently highlighted that Tsipras was likely to call for a referendum once stalemate in the negotiations had been reached. From my perspective, this was a straightforward deduction back in January, given the inconsistent desire of the Greek electorate to remain in the Euro whilst rejecting further austerity, and which Tsipras fully exploited in his election campaign.

So what now?

The first point is to examine the likely wording of the referendum. Whilst this has yet to be finalised, the following passage (a direct translation from the website of the Greek Parliament) gives a taste of what we might expect:

The Greek people are being called to cast their vote as to whether the proposed agreement, which was submitted by the European Commission, the ECB and the IMF at the Eurogroup of 25/6/2015 and which consists of two documents that together constitute their proposal, should be accepted. The first document is titled ‘Reforms for the Completion of the Current Programme and beyond’ and the second ‘Preliminary Debt Sustainability Analysis’.

Any citizens that reject the proposal of the three institutions vote NOT APPROVED/NO.

Any citizens that agree with the proposal of the three institutions vote APPROVED/YES.

The referendum is being proposed by the ministerial council so that the Greek people, after being thoroughly briefed about the developments at the intensive negotiations which began on 20/2/2015 and are still ongoing today at the highest statutory levels of the of the European Union and the Eurozone, can take a position with regard to the content of the proposal of the aforementioned three institutions and authorise the government to continue handling these negotiations toward the achievement of an agreement, with the people being called to have the first say about this agreement.

The referendum is proposed to be held across the country on Sunday 5th July 2015…

Clearly, the Greek electorate is not being asked, overtly at least, to vote on continued Euro membership. Instead, the referendum is worded in such a way that they are simply being asked to vote Yes or No as to whether or not Greece should accept the creditors’ proposal; let us ignore for now the introduction of the Kafkaesque element by virtue of the fact that it is unclear as to whether the proposal on which the Greek electorate is being asked to vote is actually still on the table or is likely to expire along with the current programme on June 30th, as well as the fact that the average Greek may or may not be cognisant of the actual contents of the proposal. More worryingly, there is no indication in the official line that a ‘No’ vote would necessarily result in Greece’s expulsion from the Euro; indeed, the words “…and authorise the government to continue handling these negotiations…” suggests a certain continuity rather than an abrupt finality. More crucially, it is apparently the case that the proposal Tsipras was offered on June 26th (and rejected outright) was more lenient than that of June 25th. So the referendum is being framed around what is not even the final and best proposal of the creditors to date. This suggests that Tsipras’ real intention lies elsewhere.

We should highlight Syriza’s attempts to guide the electorate towards a No vote: in the announcement regarding the referendum, the government made a point of advising the electorate to reject the creditors’ proposal by voting No. Additionally, Syriza called for a rally on Monday night in Athens for all those opposed to austerity in a clear attempt to foster support for a No vote in the referendum. The required minimum turnout of 40% of the electorate being met, a simple majority vote of 51% of this would suffice to decide the issue – at the lowest acceptable level of turnout, that’s a mere 20% of the Greek electorate.

Whilst we cannot say with complete certainty whether or not a No vote on July 5th would trigger Grexit, comments originating from within the Eurogroup to the effect that the creditors, post-referendum, would find themselves unable to negotiate with a Syriza government suggest that such would be the case (a No vote being a ratification of Syriza). The strong intimation by the creditors that the proposal on the table is pretty much the final offer also implies that there would be little room for further negotiation in the event of a No vote (assuming the creditors could actually bring themselves to re-open discussions with a newly-mandated Tsipras).

On this important point, I think a large degree of complacency both within and outside Greece stems from the often quoted statistic that c.80% of Greeks want to remain in the Euro. Some have argued that, since this is the case, the Grexit scenario is a relatively low probability event, with the most likely outcome that Greece remains in the Eurozone. However, we should juxtapose this statistic with the (current) high approval rating of Tsipras and Syriza, with recent polls showing that around 50% of Greeks approve of Tsipras’ handling of the negotiations. Tsipras, having advised the electorate to reject the creditors’ proposal by voting No in the referendum, has stated that, in the event of a Yes vote, he would step down from office. This means that the referendum is also a vote of confidence in Tsipras. This conflation of the two issues in one vote muddies the waters. If, as a Greek, you happen to believe that Grexit is an unlikely outcome, false confidence having been inculcated by media reports to the effect that this is but a distant eventuality, it becomes quite possible to hold the seemingly inconsistent desire to vote ‘No’ on July 5th, yet wish to remain in the Eurozone. This suggests that the referendum is likely to be much closer than would have been expected. It will be a task for the Eurogroup to intimate via the media that the referendum on July 5th is a de facto vote on continued Euro membership.

Tsipras, in true demagogic fashion, has been careful to steer the debate along populist nationalist lines. His speech ahead of the parliamentary vote on calling a referendum was loaded with emotional language, portraying the creditors as seeking the ‘humiliation’ of Greece. Furthermore, the very framing of the referendum question is such that a No vote constitutes a rejection of the creditors’ proposal (rather than the alternative phrasing: ‘Should we reject the proposal: Yes or No’). This echoes the ‘big No’ that has symbolic resonance for Greece as a nation (for this reference to Metaxas’ response to Mussolini cf my post ‘The Greek Tragedy Unfolds…‘) and which Tsipras has evoked in previous speeches in which he has expressed his determination not to capitulate to Greece’s creditors. Tsipras is clearly hoping that he can rally nationalist sentiment to secure the result that he seeks.

Indeed, carefully reviewing the stance Tsipras has adopted throughout these negotiations, it is tempting to postulate that his real agenda was geared towards Grexit from the very beginning. In a manner that has strange echoes of Putin, Tsipras has sought to play the card of populist nationalism, taking the country in a direction likely at odds with the economic interest of its populace. According to the so-called ‘duck test’, “If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck’, it is difficult to see Tsipras’ call for a referendum, combined with him simultaneously advising the electorate to vote No whilst neglecting to inform them of the likely impact of such a vote on Greece’s continued Eurozone membership, as anything other than a duplicitous attempt to take Greece out of the Euro through the back door. Once out, and after the initial chaos has subsided, Tsipras perhaps envisages state-sponsored largesse (with the printing presses running overtime) as the solution to his country’s problems. If so, he is sorely deluded: that is an intellectually bankrupt economic policy that has not once succeeded in creating wealth in any country in which it has been enacted. It is to be hoped that the Greeks will see Tsipras’ snake-oil for what it is.

The remaining significant factors pertain to the immediate financial ramifications of the referendum announcement. Since Tsipras’ request for a bailout extension to allow the referendum to take place whilst Greece is still in the programme has been rejected and the Greek negotiating team has previously stated that Greece’s ability to make the IMF payment due on Tuesday 30th June was contingent on them reaching a timely agreement with its creditors, this almost certainly means that Greece, technically at least, will be in the ignominious position of defaulting on the IMF. Will a technical default automatically trigger Greece’s ejection from the Eurozone? Having raised this possibility in a previous post (cf ‘The Greek Tragedy Unfolds…‘), I think that now a referendum is on the table, a way will likely be found to gloss over this issue; the possibility that the Greeks vote Yes, simultaneously signalling that an agreement can be reached as well as ejecting Tsipras from office, will be too tempting a prospect for the creditors to ignore. The possibility of cross-default to other creditor loans is consequently extremely unlikely, with Greece’s position vis-a-vis the IMF likely to be described as ‘in arrears’ rather than ‘in default’. If the Greeks vote to accept the creditors’ proposal, voting Yes in the referendum, I am sure ways will be found to make good the payment retrospectively by providing emergency funds to the new government. In this scenario, actual default would not come to pass.

The bigger question regards the impact on the Greek banking system. Sunday’s vote of the ECB’s governing council has resulted in a decision to leave the ELA in place at the previously agreed level. In this way, the ECB can point to continued support for Greece without increasing exposure. In response, the Greek government has announced that it will implement capital controls, with the banks to remain closed on Monday. Restrictions are also to be placed on electronic transfers and daily cash withdrawals. This no doubt reflects the pace of depositor withdrawals that was apparently witnessed over the weekend, with little headroom probably remaining on the recently agreed ELA limit. It is as yet unclear as to whether the reopening of the banks is contingent on Greece receiving an extension to the current bailout that would tide it over until the referendum, which Tsipras has requested for the second time. If so, this is unlikely to be granted and the banks will likely remain closed until after the referendum.

The scenario where the Greek government decides to re-open the banks in the absence of an increase in the ELA cannot be fully discounted. Syriza may decide that it is strategically opportune to precipitate a highly publicised collapse of the banking system ahead of the referendum as a means of generating further negative sentiment towards Europe in an attempt to secure a No vote on July 5th. In this scenario, the ECB may have to act – Draghi stretching the bank’s mandate to the utmost – by raising the ELA limits so that the Greek banking system can be supplied with sufficient cash to meet customer demands until the referendum takes place. That the importance of winning the media battle is appreciated by the Europeans is evidenced by the recent announcement by Juncker that the exact details of the creditors’ (final) proposal will be made public to the Greek electorate. The ECB may be called on to bolster the PR effort in those few days leading up to the referendum.

In conclusion, this is going to be a lot closer than expected. I don’t believe the markets have factored in anywhere near a 50% probability of Grexit, suggesting significant downside for the Greek equity market (when it eventually re-opens).

In the event of a No vote, Greece is likely to be ejected from the Euro, with the banking system recapitalised post-event with a combination of newly printed drachmas and (quite possibly) depositor ‘bail-ins’. Any ensuing chaos in the markets should be used as an opportunity to build long positions in periphery equity (ex Greece); the ECB will supply unlimited liquidity to shore up markets and will almost certainly prove successful in containing the fallout in a Grexit scenario.

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