MacroPolis

The recent events in Italy have reminded complacent decision makers and investors of the importance of political risk in the euro area. Disregarding political dangers emanating from Rome for too long has created costs and given rise to negative feedback loops in other countries. The “Italian crisis” is now a major concern of policy makers in Athens who see their ‘clean exit’ narrative and the Greek “success story” at risk of becoming collateral damage.

Similarly, politicians and market analysts in Berlin, Paris and Brussels are using different means of public intervention to voice their concerns about the material (i.e. financial) consequences and future political effects of the impasse in Rome. But what is frequently missing in their statements is a degree of introspection, namely to what degree they have contributed to the confusion that is now emerging in Italy.

But what does the fallout mean for Greece? Foreign minister Nikos Kotzias was in Berlin this week and heard from his newly appointed German colleague Heiko Maas how well Greece has developed. Meanwhile the latter’s predecessor – Sigmar Gabriel – was speaking at the annual Federation of Greek Industries (SEV) meeting in Athens. He also praised the government’s reform efforts and lamented the slow response to debt relief proposals for Greece.

But the new German finance minister appears to have a rather different perspective on recent developments and future perspectives of Greece. Olaf Scholz, a Social Democrat (SPD) is not known like his famed predecessor – Wolfgang Schäuble – to bring the proverbial gun to every knife fight. However, given Scholz’s latest statements regarding Greece, it is not far-fetched to stipulate that Schäuble’s spirit lingers on in the corridors and offices of the SPD-led finance ministry in Berlin.

During the past months the Greek government and its dedicated cheerleaders in Brussels had painstakingly prepared the “clean exit” narrative with the advocacy of two critical policy initiatives. One was to increase the maturities of existing loans to Greece by up to 15 years. The German finance minister said “Nein.” In Scholz’ view three years are enough.

The second issues concerns the creation of a mechanism which automatically links debt relief measures with certain parameters of future GDP growth in the Greek economy. The International Monetary Fund in Washington, French president Emmanuel Macron and Klaus Regling from the European Stability Mechanism (ESM) had all supported the proposal. But the reply from the German Finance Minister Scholz was vintage Schäuble, i.e. he opposes the mechanism, the manner in which GDP is calculated and how it should be linked to debt relief.

This opposition in Berlin – which extends well beyond the Finance Ministry and deep into the German Bundestag - creates a major dilemma for the political authorities in Athens. While they are discussing clean exit strategies with the troika and the conditionalities of the post-programme environment for Greece, the most important interlocutor in the euro area is yet again playing political hard ball.

But before reaching the promised land of August 2018, the debate about the parameters of a “clean exit” will continue to define the agenda, more so than speculation about debt relief measures for Greece. How “clean” such an exit strategy can be for the Greek authorities and what degree of leverage the international creditors will retain is at the heart of this very public controversy. It is as much about hardcore politics as it is about institutional responsibilities and regulatory oversight.

The advocates of a clean exit strategy emphatically reject the possibility of accepting a precautionary credit line (PCL) to lend support to Greece in a post-programme arrangement. They argue that the cash buffer piling up in the coffers of the Finance Ministry in Athens and successful returns to international capital markets neither make such an option necessary nor politically desirable. In other words, clean exit means no strings attached and freedom from the troika’s demands.

But how realistic is such rhetoric, put forward as much for domestic political consumption as it is meant to serve as the cornerstone of the Greek success story? Let’s look at some facts:

• Greek government bonds (GGBs) are still five (!) notches below investment grade. Given the uncertainties in Italy and rising political risk in Spain, GGB spreads have increased again recently. Athens is now materially experiencing – but in reverse – what contagion through risk factors in other euro area member states feels like. It is unlikely to stop soon.
   
• Unless the European Central Bank (ECB) is prepared to continue issuing the waiver for GGBs in connection to refinancing operations by Greek banks, the participation of Greek sovereign debt in the ECB’s quantitative easing (QE) programme is legally impossible. The policy makers in Frankfurt have repeatedly argued that a precautionary credit line would help in keeping the waiver operational.

The advocates of a clean exit frequently argue that the mounting cash buffer leaves enough leverage for the Finance Ministry in Athens to operate post-August 2018 without a PCL. But what happens when funding costs for sovereign debt increase and spreads continue to widen? Is recourse to the cash buffer then a viable option?

The moment the authorities in Athens would even consider such a move, capital markets would trounce Greek government bonds. A cash buffer has a key similarity with a precautionary credit line: the raison d’être for both of them is that they exist in order for policy makers not to have to touch them. Relying exclusively on international capital markets for sovereign debt refinancing arrangements also includes accepting that these markets will take notice if domestic funding challenges arise from external risks that may require recourse to a cash buffer precisely because a PCL is not available.

Italy and Greece are in the same region, not only geographically, but also regarding various parameters of both countries’ risk profiles. Upheaval in Italian markets has blindsided complacent decision makers and many investors. Both are now reacting with different means of crisis management. June 2018 in Rome is not June 2015 in Athens but all participants would be advised to heed the lessons learned from three years ago.

*You can follow Jens on Twitter: @Jens_Bastian