The Greek Default Threat: Bluster or Bombshell?

The Greek Default Threat: Bluster or Bombshell?

Kostas Tsironis

A flurry of conflicting headlines brought Greece back to the forefront for investors this week on reports that Athens will consider a debt default should negotiations with the European establishment fail.

Although this isn't really news (it was always the "Plan B") and was quickly denied by officials, it brought back to life an issue that many had been comfortably ignoring. Adding to the confusion was word the Greek government could be looking at holding early elections to try to strengthen its negotiating position with Brussels. The government has also been cozying up to Moscow and Beijing recently in what's tantamount to throwing sand in the eyes of their Eurozone overlords.

Related: Why Greece Should Consider a Eurozone ‘Grexit’​​​

The situation is heating up again ahead of the next Eurogroup meeting on April 24, which German daily newspaper Handelsblatt believes is unlikely to produce a new bailout deal, citing European Commission Vice President Valdis Dombrovskis. Without a deal, the Greek treasury could run short of funds, bringing a debt default — likely on International Monetary Fund loans first — into the realm of increasing possibility as soon as the end of the month. U.K. bookmaker William Hill has closed betting on whether Greece will leave the Eurozone, saying that it looks “increasingly likely” that the process will start soon.

The hang up, as it's been since the leftist Syriza party was elected earlier this year — the first democratic victory for the hard left in post war Europe — is agreement on the economic reforms and budget austerity measures Athens must commit to in order to unlock further assistance.

It's a Morton's fork: Austerity measures have crushed the Greek economy, which suffers a 26 percent jobless rate, but exit from the Eurozone would demolish its financial system.

The April 24 meeting in Riga is not expected to close the gap on these issues, including pension and labor market reforms. That would push the deadline for agreement to the meeting of Eurozone Finance Ministers on May 11.

Related: Macro Wars — The Attack of the Anti-Keynesians​​

For now, the situation is held in an uneasy stasis by incremental expansions of the European Central Bank's Emergency Liquidity Assistance funding to Greece's banking system, which has suffered deposit outflows on fears Athens will soon have no choice but to dump the euro and restore the drachma.

But hopes are diminishing. On Tuesday, the Director of the IMF's European Department, Poul Thomsen, warned that negotiations with Athens were "not working" and that he could not envision a successful conclusion to the current bailout. Independent Greeks party leader Panos Kammenos, a part of the ruling coalition and the Greek Defense Minister, said earlier this week that the government would not sign off on new austerity measures.

Kammenos attracted attention in March by warning that if Greece was forced out of the Eurozone, it would use its European Union membership to flood Western Europe with immigrants, including jihadists from ISIS. Those comments echoed similar ones from Nikos Kotzias, the Greek foreign minister.

The Financial Times reported on Monday that Athens would decide to withhold $2.5 billion in payments to the IMF over May and June if no deal was reached — effectively tearing up the five-year-old EU-IMF deal that amounted to a total of $245 billion in rescue loans to fulfill election promises to prioritize the needs of Greek pensioners and domestic commitments.

Related: Greece Needs Deal with Lenders on April 24 

Is this just bluster? Another negotiating tactic?

Alberto Gallo, head of European Macro Credit Research at RBS, notes that while Athens' solvency through the rest of April seems secure without further aid disbursements, the $3.7 billion in total principal repayments due in May could prove troublesome.

The noose has been tightened by renewed weakness in the economy, which slumped 0.4 percent at the end of 2014 to end three consecutive months of growth, the first positive stretch for the troubled Greek economy since 2009. Government revenue came in below expectations in January and February, leaving Athens without the dry powder it needs to demand a workable compromise from its creditors.

A default on the IMF portion of its obligations wouldn't necessarily cause the situation to spiral out of control. Athens would enter a 30-day grace period, during which negotiations could continue. But the IMF is likely to withhold its portion of remaining bailout funds. And any move by the ECB to reduce its support of Greek banks would put a quick end to the dance.

Taking the other choice and delaying payments to public-sector workers (and possibly pensioners) would result in the rapid loss of public support (approval ratings are currently near 45 percent) and possibly even the breakup of the ruling coalition as the most ardent leftists balk.

Gallo points to evidence suggesting a debt default cannot be easily dismissed as mere bluster but may represent the least painful choice for Prime Minister and Syriza firebrand Alexis Tsipras. Actions speak louder than words, and the legislation Tsipras has passed so far are inline with his campaign promises: Emergency help for the poorest and partial personal tax relief. These changes haven't been revenue neutral, angering the country's creditors.

Gallo concludes that there is an increased risk of a cash shortfall for Greece in the weeks to come that could trigger a soft default on interest payments. This won't necessarily result in a "Grexit" from the euro and a hard default on principal balances, but will greatly increase the odds of a policy mistake that pushes the situation past the point of no return.

The epicenter will be Greek banks, which are likely to come under capital controls in a desperate effort to stem deposit flight and buy the diplomats one last chance at healing the rift on Europe's eastern flank.

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