Will Greece Default ?

First Published on 24th June 2015

The China Republic, world’s second largest economy, has been outperformed by Greece, a country on the verge of default. Recent Google search data showed that in the month of June market participants have searched Greece crisis significantly more than a brewing Chinese crisis. The Greece crisis has been at center stage ever since the victory of Alexis Tsipras, who had won the Greek election on the promise of reducing austerity. Mr. Alexis Tsipras believes the EU and IMF must ease the terms of the loan and leave Greece independent when it comes to fiscal policy. On the other hand, the EU and IMF leaders have little faith in the Greece policies and want to implement strict norms to achieve a fiscal surplus.

The Greece has to make a payment of € 1.6 Bn, which it does not has, by Tuesday to IMF to avoid the default. Hence the Greece has continued on its hitherto followed path of negotiating with its lenders to issue a new loan to repay the previous one. First things first- will Greece default this month, or say, this year? From a game theory perspective the answer is ‘A Big No’. From the perspective of Greece, ‘An event of default’ would be a disaster and it would take at-least a decade if not more to regain the confidence of investors. From the perspective of lenders, EU and IMF, ‘An event of default’ might lead to a chain of defaults in Europe, pushing back European economic recovery, which is already breathing on borrowed oxygen. On the other hand, a deal will be a more of a balance sheet transaction than cash Flow. The funds sanctioned by lenders will be used to repay the loan to the same lender. Hence, both the participants have a lot of incentive to avoid default in near term.  

What will happen in the long term? Frankly speaking, Mr. Tsipras has made electoral promises (high pension, high wages and high public spending) which he just can’t not afford. From the political perspective, this case has few things in common with the situation of Aam Aadmi Party in Delhi, where in Mr. Kejariwal had made unrealistic and anti-growth promises just to gain short term popularity. Just like Mr. Arvind Kejariwal has to hike the electricity bills Greece will succumb under EU pressure. Greece political class must understand that it can no longer afford recurring negotiation with lenders and it should start putting growth above the public friendly policies.

For European Union and IMF, it is more of problem of principle than funds as ECB is already printing nearly € 2 bn per day, more than Greece’s current payment. The European Union wants to set an example that an indebted country must practice policies of fiscal discipline, which will result in fiscal surplus. Unlike Greece, other troubled European countries like Spain has running a plunging primary budget deficit, strong growth, rapidly rising productivity, and a burgeoning trade surplus.    

At last, the biggest risk for the financial markets is the reckless behavior of Greece leaders, who believe that EU and IMF just can’t afford a Greece default. A similar state of mind was shared by Dick Fuld, CEO of Lehman Brothers ultimately leading to the demise of the bank.

Source: Google Trend Bloomberg