- Greece and its creditors are moving closer to a deal for an ESM programme…
- …we identify five challenges that could throw the process off course in coming months
- Meanwhile, the IMF warns Portugal on reforms ahead of the 4 October elections
ESM deal for Greece looks to be approaching
Greek government bonds and equities rallied on Monday on optimism that Greece and its creditors were nearing a deal on a EUR 86bn ESM programme. A Commission spokesperson said that a deal could be reached by 20 August. In the case that a deal is reached later, Greece will need a new bridge loan, but in any case, the chances of agreement look high.
Five potential pitfalls
Does that mean Greece is out of the woods? Unfortunately not. There are a number of potential pitfalls that could knock the deal off course in coming months, which would once again raise Grexit worries. So here goes:
1. Deep recession: The economy looks set for another sharp dive, contracting 3% this year and 5% next year in our view. That will be a very tough environment to implement difficult measures.
2. Austerity: Although we do not yet have the details, it seems likely that Greece will be asked to carry out further sharp budget cuts. With the economy slumping, these may prove counter-productive, leading the country to miss targets as tax revenues plummet.
3. The debt mountain: With government debt heading for 200% GDP or above, Greece needs major debt relief. A number of eurozone member states sound like they only want to provide a modest debt reduction by extending maturity of debt, but that may not be enough.
4. Insufficient finance: The ESM will provide EUR 50bn of the EUR 86bn needed. The IMF may provide EUR 15bn, but even then there is a financing gap.
5. Lack of ownership: Greece, Germany and the IMF have expressed doubts about the programme. What happens when the going gets tough?
The IMF has warned Portugal’s political parties ahead of the general elections on 4 October. It said that “with increased financial market volatility in the context of developments in Greece, it is crucial to ensure that investors retain confidence in the direction of economic policies in Portugal”. The IMF mentions that the new government has to step up the pace of structural reforms. On the positive side, the IMF notes that the country’s economic recovery remains on track and that the authorities have made progress in reducing government debt, which is expected to have peaked in 2014 (at 130% GDP) and should decline steadily beginning this year.
… no radical parties in the race for government
At the moment, the Socialist Party has a small lead over the ruling centre-right coalition of PSD and CDS-PP in the polls. Although the SP is anti-austerity, it is has a much more moderate agenda than for instance Greece’s Syriza party or Spain’s Podemos party. The SP has emphasized that a government under his leadership would honour the country’s fiscal commitments to its creditors. Moreover, he aims to meet Portugal’s fiscal consolidation commitments by adopting less austerity in exchange for more reforms that will support economic growth and employment.