Tsipras’ Pyrrhic victory

The people have spoken, and Greece will stay on a course which will take the country further still into unchartered waters. It is a triumph for Alexis Tsipras at home, but unless he can demonstrate how he can pull off a strategy of gaining debt relief before reforms, it could quickly become a Pyrrhic victory for him abroad.

For Greece’s Eurozone partners, they now know that their negotiating partner will continue to be a Syriza-led government, and they know that Syriza’s belief in their own strategy of forcing the EU and IMF into writing off debt maturing in 2015 has been bolstered. On its own, the outcome of the referendum will not increase the willingness or likelihood of Greece’s partners to cut such a deal but what may is the spectre of a further deterioration of the situation in the country.

In this first place, it seems likely that this drama will take place with Greece inside the Eurozone; Greece is not willing to leave and the EU lacks the instruments to force the country out. If the suffering of the Greek people continues it seems plausible that Greece Tsipras may be able to play off the need for solidarity of Europeans with the Greek people. The EU and EU member states’ notion of cohesion and their idea of integration in Europe will mean that they could well come to the rescue should the humanitarian toll run high. Tsipras seems to know this and so is able to trust in this European reflex.

What seems unlikely to happen is fundamental reform of the Greek state. By the standards of the EU, Greece is a failing state, a republic with a minority of republicans. This is neither new, nor is it a consequence of the referendum but, rather, has been the case for many years and was brutally exposed by the financial crisis of 2008. Neither the Syriza government nor its predecessors have shown sufficient political will, have received the necessary popular backing, or have had the administrative ability to thoroughly change the republic, to build a new state on the pillars of good, accountable and effective governance. Sunday’s referendum result makes such reform seem farther away than ever.

But if Greece has historically been unwilling or unable to make the changes, the inability of the IMF and the EU to enforce such change has been categorically exposed. Their help has bought Greece time and the conditionality of such support has led to massive cuts in the public budget, but did not fundamentally solve the problem. The failure of successive Greek governments and of international institutions has, in the end, resulted in diminished ownership for change in Greece, in the externalisation of political responsibility, and in the rise of the extremes to power.

In this perspective, what will be the next steps, what could Tsipras do, and how could the Eurozone, the EU and the IMF respond?  

Firstly, this week, the Greek government will return to Brussels and demand a new round of negotiations. It will concede to pick up various but not all pieces of the June 25 interim results and add a debt relief scheme to it, covering all the outstanding debt until the end of the year. Without relief, Tsipras will not sign anything, and rather threaten not to service the other IMF and ECB debt maturing over the next months.

For its part, the IMF has almost no room to manoeuvre: it is bound by its rules. Arrears procedures have already been launched, and Greece cannot receive any further funding through the IMF. Furthermore, in the eyes of IMF analysts, Greece’s debt sustainability is now in question. The Syriza government has done what it could to bring this conclusion about and so, if new IMF funding became available, it would require measures to achieve debt sustainability to access. This plays into the strategy of the Tsipras government: either Greece will get rid of the IMF debt altogether and not repay the €3.6 billion due this year, or it will have a strong advocate of debt rescheduling or write-off in its negotiations with the EU.

Greece’s Eurozone partners will not want to rush into an agreement with Greece. Rather than giving in to Greek demands, Eurozone governments will first have to come to a common understanding of what could work, if indeed anything will work at all. This might involve different types of conditionality and monitoring, it may well involve tutoring roles for specific member states, all of which would have to be accepted by Greece. On the basis of the June negotiations, further debt rescheduling or write-off will be out of the question. It is highly unlikely to be agreed upon by all 18 governments of the Eurozone next to Greece and will almost certain fail in one or more of the five parliaments which have to vote on an agreement.

The next IMF repayment is due on 13^th July, followed by around €3.4 billion due to the ECB and national central banks a week later. Until this point the critical situation of the Greek banking sector will remain, and therefore so will restrictions and capital controls. Should Greece fail to repay the ECB and central banks, the first real losses will have to be written off. Draghi’s options to uphold emergency liquidity assistance (ELA) to Greek banks will be exhausted and so the ECB will not provide further assistance. Greek banks, businesses and the people will have to make do with the – not small – Euro cash fund in the country but a bank run forcing Greek banks to close seems the more likely option. All of which will make reaching an agreement even more complicated than before.

Once at that point, Greece may choose not to repay the next €3.2 billion owed to the ECB that is due on 20^th August. This way, the government may continue to be able to pay its bills and salaries for another few months, pushing ahead the date of introduction of a quasi-parallel currency. In the meantime, the country’s economy will be thrown into deeper recession still without access to financial services. At the same time, the Greek government would put into effect its own version of debt reform, defaulting on a part of the €21 billion debt to the IMF, and a part of the €27 billion owed to the ECB and central banks. Unilaterally, Greece will create facts on the ground, in the hope of sustaining this new reality at the negotiating table later. Political conflict will rise in tandem with this unilateralism as some EU governments demand retaliation, vetoing any further concession to Greece, and driving the two sides further apart.

With neither side willing to give in, it is hard to see how this sequence of events could be avoided. And matters could get much worse as even this nightmare scenario assumes that the Greek public to remain calm in the middle of the political storm that is about to unloaded on them. In the referendum campaign, Tsipras has appealed to the pride and identity of the Greek people – David resisting Goliath – and while this perception will help over the next few weeks, it will not last forever.

In response, Eurozone architects need to move quickly. If all sides stick to their guns, a small segment of the Eurozone could tear monetary union apart with spill-over into the EU at large, create frictions in essential policy areas such as the single market and Schengen. The Kremlin will be watching with growing pleasure. But with Germany and France in the driving seat, there remain significant obstacles. Merkel and Hollande cannot give into Greek demands without creating potentially bigger problems for themselves. Any perception of a victory for Syriza could damage the situation in Spain and Portugal. And while Germany could step in for Greece financially to break the deadlock, without new commitments from Athens, this would be the end of Merkel’s chancellorship. So we’re back to where we started. Movement on the debt issue will have to be linked to a programme of deeper reform. There is no other way.