From the Desk of Robert Dye

Thoughts About Greece as the June 5 Payment Deadline Approaches

According to today’s Financial Times, Greece owes a 300 million euro payment to the International Monetary Fund on June 5. There is widespread concern in global financial markets about Greece’s ability to pay, and speculation about Greece’s future inside or outside of the European Union. Often, the many issues surrounding Greece debt payments are rolled up into one big question…can Greece stay in the European Union? This assumes that there is a mechanism for leaving the EU, which there is not, and that Greece would be a successful state if only they could free themselves of the fiscal (taxation and spending) and monetary (currency, interest rates and money supply) controls imposed by EU membership. That is a big “if.”

GREXIT draws attention to the possibility of a failed and unstable Europe. The financial reporting on the crisis in Greece often conflates several issues, rendering the analysis meaningless. Let’s untangle the issues first by saying that Greece’s willingness to make the payment on June 5 does not necessarily equal their ability to make the payment. It appears likely that Greece will need a deal in order to have the ability to make the payment. Second, even if they are willing and able to make this payment, there may be future struggles involving later payments.

Greece appears to have both a liquidity crisis and a solvency crisis. Being liquid enough to make the payment on June 5 does not guarantee that the country can remain solvent over the long-term. Fiscal controls (spending cuts and revenue collections) are needed to insure long-term solvency. Tighter fiscal controls for Greece, however, raise the possibility of political instability, an adverse feedback loop that could have spillover costs for all of Europe. So here we see the linkage between the financial issue and the political issue for Greece.

To better understand the progression toward GREXIT, let us assume that the near-term liquidity crisis cannot be solved. There is no deal between Greece and the troika of the IMF, the European Union and the European Central Bank. The willingness and ability of Greece to make the payment evaporates, and Greece holds onto its liquidity, but potentially remains long-term insolvent.  If Greece cannot fulfill its obligations to its creditors, then it defaults, which is a legal issue.

In order to analyze the consequences of a Greek default, we need make some assumptions about the type of default. A default could be structured, or negotiated, and not have catastrophic consequences for the creditors. Or a default could be unilateral and unstructured, with disastrous consequences for creditors and other counterparties. We assume that if Greece cannot make its payment to the IMF, then the IMF as an institution is not severely damaged. However, if Greece were to default on other obligations, such as on payments to holders of its sovereign debt, then individuals and institutions holding that debt could be damaged. A Greek default on its obligations would raise serious concerns about their ability to borrow money as an independent state after their exit from the EU.

Because we have no better way to assign odds to the process of GREXIT, let’s use the universal oddsmaker, a coin toss. Let’s set the probability of a missed payment on June 5 to be 50 percent. Let’s assume that the missed payment leads to a negotiated default and a restructuring of the loans by the IMF. Let’s assume that Greece does not default on its other sovereign obligations so that the damage from a Greek default is minimal. Let’s assume that a default on its IMF loan by Greece has a 50 percent chance of initiating the political process of a Greek exit from the EU. Then we can say that there is a 25 percent chance ( 0.50 times 0.50) that Greece will exit the EU soon.

While the ability to predict the final outcome of the Greek crisis is well beyond anyone’s ability, I hope that this brief discussion adds some value to your analysis of this very complex situation.

This entry was posted in From the Desk of Robert Dye, General, Global Economy and tagged , . Bookmark the permalink.