Who will blink first — Greece’s new government or the European institutions and governments that have delivered nearly €200 billion in financial assistance to the stricken country? That has been the question at the top of many minds ever since Alexis Tsipras and the radical left Syriza won the January 25 elections in Greece on an anti austerity, debt-cutting platform.

Both sides seemed to be in an unresolvable predicament — on the one hand Tsipras and his government are unlikely to back away, fundamentally, from the sizeable pledges they’d made ahead of the election — including undoing some of the structural reforms carried out at the behest of its creditors, the troika of the IMF, European Central Bank and European Commission, rehiring thousands of civil servants, putting a halt to privatisations and negotiating a reduction in its debt burden.

On the other hand, European leaders too have limited room for manoeuvre. While Europe’s strongest northern economies will struggle to convince their publics, and crucially parliaments of the need to be flexible, governments in southern Europe will also be wary of delivering anything that could be perceived as a victory for Syriza. They would be fearful that it could further accelerate radical anti-austerity movements and political parties in their own countries — a genuine possibility in Spain where the Podemos party has been surging in the polls ahead of a December general election.

While Greece and its debts on its own pose a limited threat to the rest of Europe (thanks in part to the €500 billion European Stability Mechanism and the ECB’s recently announced quantitative easing) its knock on effects on the rest of Europe are sizeable both for Europe, and its trading partners globally.

No collision in sight

Fortunately for investors and the global economy, initial signals from the Greek government suggest that the tricky question may not need to be confronted after all. Just over a week since taking office the new Greek government has begun to send out crucial signals that its stance is continually evolving and isn’t quite as set in stone as many believed.

During his visit to London this week, finance minister Yanis Varoufakis, a respected radical economist, who had previously referred to the austerity regime as “fiscal waterboarding” outlined a plan more likely to go down well in capitals across Europe.

In an interview with the Financial Times, he made it clear that the government would not necessarily follow through on all the structural reform reversals it had talked about ahead of the election, and would continue to run a primary surplus of around 1 to 1.5 per cent, down from around 2 per cent last year.

It will also request some €1.9 billion from its creditors before the current assistance package expires (contrary to previous more defiant statements that it required no further payments), a figure equivalent to the ECB’s profits on the Greek government bonds it purchased at the time of the 2010 rescue, but an acknowledgement that Greece would need to seek ongoing support from its creditors.

He’s also proposing re-structuring its debts — rather than outright haircuts, he is proposing a mixture of two things: replacing the loans from the EU (the EFSF and the bilateral loans) with bonds indexed to growth (an idea he had mooted in the past) and “perpetual” bonds for the ECB tranche of them.

EU and bilateral financial assistance make up the vast bulk of the over 240 billion in aid that have been given to Greece so far (around 140 billion euros from the EFSF, 53 billion in bilateral aid, over 20 billion from the ECB and around 28 billion from the IMF).

Uncompromising Europe

Quite how Europe will respond to the Greek proposals remains to be seen — German Chancellor Angela Merkel has been cautious in her response to these proposals so far, pointing out that the Greek government was still in the process of shaping its agenda.

However, the proposal for perpetual bonds might be one that is hard to swallow. “It sounds a lot like debt forgiveness,” says Christian Schulz, a senior economist at Berenberg Bank in London.

But easing the overall terms of Greece’s debt repayments, whether by deferring the time frame or linking to economic growth, is something that could garner support across Europe, given that it has become increasingly evident that there has been austerity overkill in the region — with sluggish growth and deflation rife.

Moreover, Greece’s debt burden has risen rapidly (to 175 per cent of GDP from 120 per cent when the aid package was first agreed) while less and less of the financial assistance has been used to fund day-to-day running of public services, paying salaries and so on (one website, MacroPolis estimates that just €15 billion have been used for state operations with the rest used to meet maturing debt obligations and debt reduction.)

However, one thing is clear — it’s highly unlikely that any compromise will come from Europe without Greek action and pledges on reform first. “Without structural reform there is absolutely no chance we are going to get this through the Bundestag,” says Carsten Nickel of Teneo Intelligence in Berlin.

Some alternatives

While promises some of these have begun to trickle in (including pledges on clamping down on corruption and tax evasion), Greece will likely have to confront some of the more contentious structural reforms. These include union powers, and severance pay rules which may not have as much fiscal impact but were some of the conditions set out by the troika for the bailout package.

In doing so, Greece will have to strike a fine balance between doing enough to pacify its creditors and citizens — while keeping to enough of its pre-election pledges to maintain credibility with coalition partners and the Greek electorate.

In a situation where perception can matter more than genuine change, gestures matter, and those such as the European Commission’s proposal to potentially disband the troika — a structure detested in Greece — and replace it with a more democratically accountable supervision mechanism could score the Greek government some points domestically, giving it more freedom to be flexible in its European negotiations.

Similarly, gestures by Greece to show it is committed to reform will win it credibility in Germany. In any case chances of a Greek exit — at least an accidental one, fired by ramped-up rhetoric — looks increasingly unlikely.

“The Eurozone has all the tools in its hands to ensure they have more time,” says Schulz. Many believe Greece is likely to have the current programme — currently set to run out at the end of February — extended, and that the ECB will continue to provide emergency funding to Greek banks.

While a dramatic Greek exit is looking increasingly unlikely, equally unlikely is a speedy solution and agreements are likely to provide only temporary respite. But that may not be the worst thing for the world — one thing the Eurozone has shown again and again is its ability to muddle through even the most hopeless-looking of crises.

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