Will Syriza's bark be worse than its bite?

OverviewIn Sunday’s general election the radical left-wing party led by Alexis Tsipras seems bound to emerge as the winner. Syriza has campaigned on a programme of reversing austerity, increasing social spending and safety nets, shifting the tax burden onto the wealthy, and renegotiating Greece’s EU/IMF debt burden. That approach is seductive to the electorate. And it would not be entirely without merits. But it is anathema to Greece’s official sector creditors in the euro area and IMF. So, months of political uncertainty and tense relations with those creditors lie ahead. Nevertheless, with Greece having most to lose from a Grexit, we do not fear for Greece’s continued membership in the euro area for the foreseeable future. And thanks to the ECB, the rest of the euro area should not be overly fearful of a prolonged period of Greek uncertainty following the election.

What we expect from the electionEvery single one of the 140+ opinion polls conducted since June 2014 puts Syriza in the lead. The 40 polls held since the start of 2015, however, suggest that the gradual rise in Syriza’s popularity has levelled off this year. On average, January’s polls show that Syriza has gathered 35% of the popular vote, which would translate to 145 seats – i.e. 6 short of an absolute majority in the 300-seat parliament. We estimate that Syriza would have to gain at least 38% of the popular vote to reach 151 seats, and recent trends suggest it won’t manage this.

Syriza is therefore likely to be forced to try to form a coalition. Assuming that it wants to build a safety margin of seats – defections from ruling coalitions are common in Greece – we expect it to aim for around 160 seats. There is no obvious natural coalition partner for Syriza, although some formations are more likely than others. We see two possible options: First, Syriza could partner up with To Potami, a recently formed “Citizens’ Party” without strong political leanings but with a big grassroots appeal among voters disaffected with the mainstream parties. Alternatively, Syriza could select independent MPs who have split from other parties.

Following the election, starting with the party with the most seats, the three most popular parties each have three days in turn to form a government. After that, if there is no success, formation of a unity government will be attempted. And if this can’t be formed, as in 2012, yet another general election will be held. It is difficult to be precise about the chances of such an event, but our rough guess would be approximately 30%.

ImplicationsThis political uncertainty has coincided with the final review under Greece’s second joint euro area/IMF bailout programme (to be completed by end-February). A follow-up programme with the euro area is likely to be required to convince the ECB to buy Greek debt when that will be permitted under the terms of its new QE programme (i.e. from July on). Even if Syriza is able to form a functioning government in February, we doubt that the final programme review can be completed before the end-February deadline. This will probably force an extension of the final programme review until May or June, as the Troika is still insisting on a number of reforms to be passed before the final disbursement is made. Of course, such reforms would look less likely under a new Syriza government. Uncertainty regarding Greece’s policy direction will therefore probably persist until the summer at least.

What seems beyond doubt is that Syriza will be the dominant force after the election, and that, if and when it forms a government, it faces very difficult challenges to meet all of its three objectives of ending austerity, restructuring its EU/IMF loan debt, and keeping Greece in the euro area. We believe that no more than any two of these three aims can be jointly met for now. Euro area/IMF creditors, led by Germany, will insist on continued reform and a degree of austerity in order to ensure that Greece reduces its debt burden through consolidation, rather than debt write-off. But that doesn’t mean we should start to expect a “Grexit”, i.e. a reintroduction of a (sharply devalued) Drachma. The short-term costs and risks for Greece attached to a ‘Grexit’ are enormous, especially for the fragile Greek banking sector, while the benefits of improved competitiveness (mainly of the Greek tourism industry) are likely modest. And, of course, the potential benefits for Greece that might eventually accrue from ECB purchases of its bonds under QE might eventually be very significant indeed.

Accordingly, we believe Syriza overestimates the strength of its negotiating position vis-à-vis the Troika, who (for the reasons above) probably view a ‘Grexit’ as a non-credible threat. And if and when in government, it might well also recognise the benefits from striking a deal. So, we suspect that the inconsistency of Syriza’s three objectives will be resolved through compromises and modest concessions by the Troika towards Greece regarding the terms (but not the outstanding volume) of Greece’s bailout loans. A growing number of policymakers in Brussels have recently hinted at the scope for lengthening loan maturities further and/or reducing interest rates on EU/IMF loans. This would reduce debt service costs and could also potentially free up some room for a slightly easier fiscal stance.

ConclusionIn summary, we believe Syriza’s bark will prove to be worse than its bite. And although the next few months might well be tumultuous for Greece, the rest of the euro area should remain largely insulated from major market spill-overs and contagion, not least given the ECB’s QE, the various financial firewalls now in place (ESM, OMT), and other periphery countries’ somewhat better economic fundamentals.

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