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CHIAGNI & FOTTI SRL
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Failure of third presidential ballot heralds Greek general election
In the third round of voting on a new president, the ruling coalition failed to reach the threshold of 180 votes. The Greek parliament will now be dissolved and a general election called. The election will now take place on January 25th.
The latest opinion polls suggest that Syriza will be the largest party in the new parliament. It is possible that Syriza will need to form a coalition with one of the smaller parties in order to achieve an outright majority in parliament. It is also important to note that, given the extra 50 seats given to the largest party, it would not be possible for a coalition to be formed without Syriza, assuming it is indeed the largest party.
But, the opinion polls look to be shifting. Although Syriza has maintained its lead over recent weeks, that lead has been narrowing. A few weeks ago, Syriza’s lead over New Democracy was around 7 points (taking an average of the prior five polls). This looks to have narrowed to around 3.5 points. The extent to which this narrowing continues over the coming weeks depends on whether New Democracy is able to convince the people that the election is not really a vote for or against austerity, but rather for or against EMU membership. Given the critical issue of EMU membership, the outcome is likely to be closer than the opinion polls suggest at face value. If no coalition can be formed after the election, then another election is called. This happened in 2012, with a gap of 42 days between the elections on May 6 and June 17.
If Syriza does win the election, attention will focus on what it will try to achieve. It intends to honor Greece's market liabilities and the IMF loans, but it would like a significant restructuring of the official loans from the rest of the Euro area (€53bn of bilateral loans and €142bn of EFSF loans) which would comprise a significant face value haircut. It would also like to reverse some of the measures implemented under the EU/IMF program—eg gradually restoring the minimum wage and pensions back to pre-crisis levels, and abolishing the ENFIA tax on property—and increase public spending particularly on support for those in most social need. Aside from additional resources from debt relief, the intention is that this program of increased public expenditure would be financed by tax reform that increased the tax burden on the wealthy and eliminated tax evasion.
Given how tough the Troika has been in negotiations over recent months, it is unlikely to view Syriza’s policies very sympathetically. Negotiations about the final tranche of the current program, and what happens next, are likely to be very difficult. Although at first blush it may look as if Syriza has a strong hand, especially in view of the primary surplus, it could struggle to meet its financing needs given its intention to honor its obligations on IMF and non-official loans that are maturing next year. According to the IMF’s fifth review, Greece should have an overall fiscal deficit next year of €2.2bn (1.2% of GDP). However, it is not really clear how secure this is. According to the IMF, this position would only be achieved with additional fiscal measures (which Syriza will not want to implement). But, on the basis of that assumed position, Greece’s financing gap for next year would amount to €25bn assuming no further disbursements (this comprises €5.3bn from the current review, €7.1bn from the IMF next year and €12.6bn which was a gap that always existed). This financing gap would get larger if Syriza ended the privatization program (assumed to be worth €2.2bn) and if the region withheld disbursements related to central bank holdings of Greek debt (ANFA and SMP income assumed to be worth €2bn). Of this financing gap, €19.5bn relates to amortizing debt, of which €3bn refers to short term treasury bills, €8.6bn refers to IMF SBA loans and €7.9bn refers to medium and long term non-official debt. And, around €5.3bn represents interest payments on all debt. Although the Greek government likely has some cash reserves, and could issue more treasury bills, it is hard to see how it can honor its IMF and market obligations (interest payments and amortizations) if its relationship with the Troika breaks down to the extent that no further disbursements take place.
The other area of vulnerability for a Syriza-led administration comes from the banking system. To the extent that there are capital outflows from Greek banks, this would raise their already high dependence on funding from the Greek central bank and by extension the Eurosystem of Central Banks. In such a situation, the ECB would be drawn quickly into decisions about collateral and emergency funding for Greek banks. The ESCB is already exposed to Greece via a €42bn Target2 balance and that exposure would increase with capital flight.
In extremis, the ECB could attempt to restrict the availability of emergency funding to Greek banks in a way that forces the Greek central bank to make a near impossible choice: between honoring its commitments as a member of the ESCB under European Treaties, or enabling Greek banks to meet their liabilities on demand. If the Greek central bank were to continue to lend to Greek banks in defiance of instructions from the ECB, breaching its obligations under the statutes of the ESCB, then the ECB could take the step of restricting or ending payment flows to and from Greek banks via the Target2 system, effectively imposing a form of capital control.
In prior phases of tense negotiation between the Greek authorities and the rest of the region, it has been the issue of official funding to cover the Greek government’s primary and other spending that has given the region its key bargaining tool. If a Syriza-led administration takes a hard line in negotiations, the emphasis will no longer be on the terms of provision of the next tranche of Troika support, in our view, but rather on the pace of deposit flight and the extent to which the ECB is prepared to allow the region’s exposure to Greece via the Target2 system to grow.
Our judgment is that the region will take a tough line with a Syriza-led government, as it has with the current coalition, and that ultimately Syriza will trim its ambitions in order to ensure that it can remain in the monetary union. More OSI will take place, as was always likely, but the region will stick to net present value debt relief through maturity extension rather than face-value reductions.
This Greek political uncertainty comes at a difficult time for the ECB. On January 14, we will see the ECJ preliminary ruling on the OMT, which we think will pave the way for a sovereign QE decision on January 22. Given market doubts about whether a Syriza-led government would honor its obligations or not, the ECB is likely to be wary about buying Greek debt. Broadly speaking, the central bank has two options: either excluding countries with heightened credit risk, or including everyone but ensuring that the credit risk remains with the national central bank. It looks like the ECB is leaning towards the latter option. Thus, sovereign QE will encompass everyone but national central banks will either need to set aside capital or agree to forgo future seigniorage.
Implications for fixed income markets
The failure to elect a president is clearly a negative for financial markets. Exhibit 1 shows the updated flow chart of potential ramifications starting from the Presidential election. Since we published the first version, the gap in the polls between ND and Syriza has shrunk to roughly 3.5%-pts making the election closer than anticipated if the current trend is maintained.
Distress in Greek financial markets has historically impacted negatively other markets, but we are inclined to downplay the medium term significance of the Greek political crisis for other intra-EMU spreads for the following reasons:
The most important driver of intra-EMU spreads at the moment is the expectation of sovereign QE starting in the first half of 2015. We do not expect the political situation in Greece to affect the likelihood that sovereign QE will be implemented.
There is no country whose political situation can be directly compared to Greece’s. Portugal's political system is characterised by a lack of meaningful support to non-mainstream parties. In Italy the process to elect a new president of the Republic might be laborious in the next few weeks, but we see no threat of early elections unless they are called to cement Renzi’s position. Ireland and Spain are the countries with elections at the end of 2015 and in 2016, and where there is strong support for non-mainstream parties, but their positive economic performance is likely to provide a powerful offset.
The potential for a deposit outflow in Greece should not be discounted but Greece should be seen as an idiosyncratic situation and the interlinkages between the Greek banking sector and those in other countries are not very tight.
Indeed, peripheral spreads have come back to close to unchanged compared to the pre-election announcement levels (Exhibit 2).
Looking at the Greek market, we continue to believe that the curve should be more inverted. Exhibit 3 shows that the cumulative probability of a credit event rises too quickly given that the most obvious risk for Greece comes in 2015. We expect more inversion of the Greek yield curve, most likely due to the short end of the curve rising further; the long end might be affected by forced selling but in our view already discounts a significant amount of bad news.
Exhibit 1: The Greek Presidential vote brings a series of new risks for the Greek markets
J.P. Morgan estimate of potential outcomes following the Greek Presidential vote and their lik
Failure of third presidential ballot heralds Greek general election
In the third round of voting on a new president, the ruling coalition failed to reach the threshold of 180 votes. The Greek parliament will now be dissolved and a general election called. The election will now take place on January 25th.
The latest opinion polls suggest that Syriza will be the largest party in the new parliament. It is possible that Syriza will need to form a coalition with one of the smaller parties in order to achieve an outright majority in parliament. It is also important to note that, given the extra 50 seats given to the largest party, it would not be possible for a coalition to be formed without Syriza, assuming it is indeed the largest party.
But, the opinion polls look to be shifting. Although Syriza has maintained its lead over recent weeks, that lead has been narrowing. A few weeks ago, Syriza’s lead over New Democracy was around 7 points (taking an average of the prior five polls). This looks to have narrowed to around 3.5 points. The extent to which this narrowing continues over the coming weeks depends on whether New Democracy is able to convince the people that the election is not really a vote for or against austerity, but rather for or against EMU membership. Given the critical issue of EMU membership, the outcome is likely to be closer than the opinion polls suggest at face value. If no coalition can be formed after the election, then another election is called. This happened in 2012, with a gap of 42 days between the elections on May 6 and June 17.
If Syriza does win the election, attention will focus on what it will try to achieve. It intends to honor Greece's market liabilities and the IMF loans, but it would like a significant restructuring of the official loans from the rest of the Euro area (€53bn of bilateral loans and €142bn of EFSF loans) which would comprise a significant face value haircut. It would also like to reverse some of the measures implemented under the EU/IMF program—eg gradually restoring the minimum wage and pensions back to pre-crisis levels, and abolishing the ENFIA tax on property—and increase public spending particularly on support for those in most social need. Aside from additional resources from debt relief, the intention is that this program of increased public expenditure would be financed by tax reform that increased the tax burden on the wealthy and eliminated tax evasion.
Given how tough the Troika has been in negotiations over recent months, it is unlikely to view Syriza’s policies very sympathetically. Negotiations about the final tranche of the current program, and what happens next, are likely to be very difficult. Although at first blush it may look as if Syriza has a strong hand, especially in view of the primary surplus, it could struggle to meet its financing needs given its intention to honor its obligations on IMF and non-official loans that are maturing next year. According to the IMF’s fifth review, Greece should have an overall fiscal deficit next year of €2.2bn (1.2% of GDP). However, it is not really clear how secure this is. According to the IMF, this position would only be achieved with additional fiscal measures (which Syriza will not want to implement). But, on the basis of that assumed position, Greece’s financing gap for next year would amount to €25bn assuming no further disbursements (this comprises €5.3bn from the current review, €7.1bn from the IMF next year and €12.6bn which was a gap that always existed). This financing gap would get larger if Syriza ended the privatization program (assumed to be worth €2.2bn) and if the region withheld disbursements related to central bank holdings of Greek debt (ANFA and SMP income assumed to be worth €2bn). Of this financing gap, €19.5bn relates to amortizing debt, of which €3bn refers to short term treasury bills, €8.6bn refers to IMF SBA loans and €7.9bn refers to medium and long term non-official debt. And, around €5.3bn represents interest payments on all debt. Although the Greek government likely has some cash reserves, and could issue more treasury bills, it is hard to see how it can honor its IMF and market obligations (interest payments and amortizations) if its relationship with the Troika breaks down to the extent that no further disbursements take place.
The other area of vulnerability for a Syriza-led administration comes from the banking system. To the extent that there are capital outflows from Greek banks, this would raise their already high dependence on funding from the Greek central bank and by extension the Eurosystem of Central Banks. In such a situation, the ECB would be drawn quickly into decisions about collateral and emergency funding for Greek banks. The ESCB is already exposed to Greece via a €42bn Target2 balance and that exposure would increase with capital flight.
In extremis, the ECB could attempt to restrict the availability of emergency funding to Greek banks in a way that forces the Greek central bank to make a near impossible choice: between honoring its commitments as a member of the ESCB under European Treaties, or enabling Greek banks to meet their liabilities on demand. If the Greek central bank were to continue to lend to Greek banks in defiance of instructions from the ECB, breaching its obligations under the statutes of the ESCB, then the ECB could take the step of restricting or ending payment flows to and from Greek banks via the Target2 system, effectively imposing a form of capital control.
In prior phases of tense negotiation between the Greek authorities and the rest of the region, it has been the issue of official funding to cover the Greek government’s primary and other spending that has given the region its key bargaining tool. If a Syriza-led administration takes a hard line in negotiations, the emphasis will no longer be on the terms of provision of the next tranche of Troika support, in our view, but rather on the pace of deposit flight and the extent to which the ECB is prepared to allow the region’s exposure to Greece via the Target2 system to grow.
Our judgment is that the region will take a tough line with a Syriza-led government, as it has with the current coalition, and that ultimately Syriza will trim its ambitions in order to ensure that it can remain in the monetary union. More OSI will take place, as was always likely, but the region will stick to net present value debt relief through maturity extension rather than face-value reductions.
This Greek political uncertainty comes at a difficult time for the ECB. On January 14, we will see the ECJ preliminary ruling on the OMT, which we think will pave the way for a sovereign QE decision on January 22. Given market doubts about whether a Syriza-led government would honor its obligations or not, the ECB is likely to be wary about buying Greek debt. Broadly speaking, the central bank has two options: either excluding countries with heightened credit risk, or including everyone but ensuring that the credit risk remains with the national central bank. It looks like the ECB is leaning towards the latter option. Thus, sovereign QE will encompass everyone but national central banks will either need to set aside capital or agree to forgo future seigniorage.
Implications for fixed income markets
The failure to elect a president is clearly a negative for financial markets. Exhibit 1 shows the updated flow chart of potential ramifications starting from the Presidential election. Since we published the first version, the gap in the polls between ND and Syriza has shrunk to roughly 3.5%-pts making the election closer than anticipated if the current trend is maintained.
Distress in Greek financial markets has historically impacted negatively other markets, but we are inclined to downplay the medium term significance of the Greek political crisis for other intra-EMU spreads for the following reasons:
The most important driver of intra-EMU spreads at the moment is the expectation of sovereign QE starting in the first half of 2015. We do not expect the political situation in Greece to affect the likelihood that sovereign QE will be implemented.
There is no country whose political situation can be directly compared to Greece’s. Portugal's political system is characterised by a lack of meaningful support to non-mainstream parties. In Italy the process to elect a new president of the Republic might be laborious in the next few weeks, but we see no threat of early elections unless they are called to cement Renzi’s position. Ireland and Spain are the countries with elections at the end of 2015 and in 2016, and where there is strong support for non-mainstream parties, but their positive economic performance is likely to provide a powerful offset.
The potential for a deposit outflow in Greece should not be discounted but Greece should be seen as an idiosyncratic situation and the interlinkages between the Greek banking sector and those in other countries are not very tight.
Indeed, peripheral spreads have come back to close to unchanged compared to the pre-election announcement levels (Exhibit 2).
Looking at the Greek market, we continue to believe that the curve should be more inverted. Exhibit 3 shows that the cumulative probability of a credit event rises too quickly given that the most obvious risk for Greece comes in 2015. We expect more inversion of the Greek yield curve, most likely due to the short end of the curve rising further; the long end might be affected by forced selling but in our view already discounts a significant amount of bad news.
Exhibit 1: The Greek Presidential vote brings a series of new risks for the Greek markets
J.P. Morgan estimate of potential outcomes following the Greek Presidential vote and their lik
