No Grexit, No Haircuts, but Difficult Negotiations Ahead

February 5, 2015

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Financial markets let out a sigh of relief when they learned that the new Greek leftist government led by Prime Minister Alexis Tsipras has put aside its earlier demands that a large share of its debt be written down, that is, forgiven. Instead, the new Greek Finance Minister Yanis Varoufakis offered a surprise proposal of bond swaps. European rescue loans would be exchanged for debt linked to future GDP growth, and bonds now owned by the European Central Bank (ECB) would be exchanged for perpetual bonds, that is, bonds without a maturity date. This move takes imposed haircuts off the table. The possibility that Greece would exit the Eurozone (“Grexit”) now also looks very unlikely. Greece does not wish to leave the Zone; the cost would be too great; and its Eurozone partners have indicated they want Greece to remain.

What lies ahead is a difficult negotiation process between Greece and its creditors on the terms and conditions of a plan to address Greece’s debt situation and the dire condition of the Greek economy. This process will surely take a number of months. Indeed, German Chancellor Angela Merkel signaled that while she is willing to give Greece more time to meet its obligations, she is not in a rush to enter into negotiations, preferring to wait until the country faces a cash crunch, which appears likely when a €3.5 billion payment comes due in June. Greece’s bailout funding runs out at the end of this month, but it will have some resources to carry on for a while. The Greek finance minister has proposed a bridge financing agreement involving the issue of 10 billion euros of short-term treasury bills to provide room to reach a more comprehensive accord by June. The ECB has indicated it is unwilling to agree to this. For its part, the Greek government has said it is committed to running a primary budget surplus, one of the conditions demanded by the creditors, but the size of that surplus will be a matter for negotiation. And so the negotiation process begins.


The economy has finally stopped declining and posted instead a small 1.1 percent advance from a very depressed base in 2014. Growth of about 2.5 percent this year looked likely to forecasters before the change of government created great uncertainty about the outlook. An accord on debt that permits the recovery to continue, including conditions that consist of market-friendly economic reforms, could improve the growth outlook. An accord that adds to restrictive austerity conditions would likely check the fragile recovery. And a failure to reach an accord, followed by default, would be very harmful for Greece, for its major creditors, and for Europe. That is why we expect that an accord will eventually be reached. There could be a lot of volatility in European markets as the negotiations proceed.

It is likely that the negotiations on Greece will feed into a broader discussion in Europe on the future of austerity measures, which are encountering increasing political resistance across the continent. Even the ECB is calling on governments to do their part to encourage economic growth and counter deflationary pressure through increased fiscal stimulus. The recent massive leftist demonstrations in Spain were a demonstration of the pressures many governments are experiencing. Growth in Europe does appear likely to pick up this year, with both a cheaper euro and lower oil prices providing a modest tailwind. However, the demands for reduced austerity will remain strong.


The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.

The preceding is an abridged commentary by Cumberland Advisors and has been reposted with permission. Cumberland Advisors commentaries are available at

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