Greece
The elections on January 25th initially gave rise to a certain amount of optimism. The government formed after the victory by extreme left party Syriza initially adopted a conciliatory tone in negotiations with its creditors. The troika, a word detested by the Greeks, was renamed “the institutions” and the memorandum was transformed into an agreement. These cosmetic changes raised hopes of a swift agreement but negotiations proved to be far more acrimonious.
At the end of May, there was no sign of any agreement between the Greek government and its European partners, and the various financial deadlines facing the country are constantly being scrutinised to assess when the Greek government will no longer be able to respect its commitments.
Negotiations are therefore continuing, but keep in mind that these are currently over the release of aid linked to the existing plan, the second one granted to the country. This would involve a package of around €5bn that would allow Greece to pay money due to the IMF in June and to reimburse a portion of its arrears, but it would probably be insufficient to cover the €6.5bn due to be repaid to the ECB this summer, not to mention the following repayment deadlines.
A third aid plan will therefore have to be negotiated with the country. A minimal agreement is still foreseeable in the short term for the remainder of the second plan, but the most controversial subjects will probably be postponed to future discussions. In an interview in Les Echos on May 26th, Olivier Blanchard, the IMF’s chief economist, was very clear about the importance of reforms to pension systems and a reduction in the number of civil servants. However, pensions, together with a VAT hike, are red lines for the Greek government. Even if it is prepared to make concessions, a sizeable number of Syriza MPs reject any compromise. A referendum on a new agreement or fresh elections are therefore highly possible scenarios.
What would happen if the country were to default on payments to the IMF? Probably not much in the very short term. First, an IMF borrower that misses a payment has a month to rectify its situation. In addition, the IMF is a creditor with a special status, which is why the rating agencies have already said they would not announce a default. As such, Greek banks would be able to continue using the ELA, the emergency liquidity assistance facility. However, the ECB may demand bigger haircuts on collateral pledged by Greek banks. This is important, since if Greece ever leaves the Eurozone other than by its own choice, the liquidity of the banking system would be to blame.
To sum up, a temporary agreement may be reached in the short term, but the Greek problem would still be far from resolved and an accident cannot be ruled out.
Elections in Spain
Local elections in some regions and municipalities revealed a sharp erosion of support for the incumbent Popular Party (centre-right), whose national share of the vote fell from 37% to 27%. The Socialist Party had a slightly lower score. The result has been presented as particularly favourable for recently-formed parties Podemos and Ciudadanos. The former results from the ‘Indignants’ movement. It is on the extreme left and is very anti-European. The latter is centrist and very pro-European and has made fighting corruption a priority.
These two parties benefit from the population’s profound disillusionment with the two parties that have dominated Spanish political life for more than 30 years, many of whose leaders have been caught up in corruption scandals. Podemos did not run under its own name but supported local candidates who agreed with its ideas: caution is therefore necessary when extrapolating its results to the national level.
The undeniable improvement in the Spanish economy was the principal argument employed by the sitting government. The year on year GDP growth reached 2,6% in the first quarter and the unemployment rate has decreased steadily to 23,0% in March from a high of 26,3% two years earlier. Nonetheless, unemployment remains very high and as a matter of fact the outcome of elections is not entirely determined by the economy.
What will the different parties do? Alliances? The appeal of Podemos and Ciudadanos is that they present themselves as anti-system parties, a position that will be hard to maintain if they choose to join forces with historic parties. Podemos seems to be moving towards possible support for the Socialist party in order to capture regions controlled by the right, but Pablo Iglesias, the movement’s leader, insists on scrapping all public spending cuts and taking a range of measures against corruption. The situation in Andalusia, where elections were held in March, demonstrates that such an agreement is not easy to come by. Podemos refuses to support socialists who came out top in these elections since they do not want to give in to their demands. Ciudadanos is focusing more on the fight against corruption, especially on the organisation of primaries before the next elections.
Legislative elections are due to be held before December 20th, 2015. 350 MPs sit in the Congress of Deputies; they are elected in 52 circumscriptions, whose number of seats is determined as follows: two seats are automatically assigned to each circumscription and two to Ceuta and Melilla. The 248 other seats are assigned proportionally to the population. Overall, the election system favours the biggest parties but without any premium mechanism helping to create a majority. Nationally, the Popular Party remains ahead in opinion polls. These reveal a relative erosion of support for Podemos since the start of the year and a sharp increase in the scores obtained by Ciudadanos. Podemos may also suffer from a failure by Syriza in Greece. If this trend continues, Ciudadanos may prove to be the king maker. In this case, the upcoming elections would represent a far lower risk.
The result of elections shows that bipartisanship and the relative stability its creates will give way to a far more fragmented parliament. But this was also the expected result of UK elections, which, defying all expectations, gave a majority to the Conservatives. It will therefore be necessary to continue monitoring how the Spanish political situation unfolds without drawing hasty conclusions from the latest elections.
Conclusion
At present, these risk factors are not having any material impact on European markets.
In Greece, we think the situation is radically different from that in 2011. The European banking system is no longer exposed to the country in systemic proportions. ECB bond purchases should prevent spreads from soaring. Furthermore, growth has returned. In the scenario of a Greek exit, whose probability we estimate at 30-40%, we do not foresee any impact in the medium term, beyond an impulsive reaction by the markets. In the longer term, it is certain that a country’s exit from the Eurozone would raise questions about the latter’s architecture. But such an event could also have a virtue in demonstrating the consequences of a Eurozone exit, which would be deeply negative for the country concerned.
As for Spain, it is undoubtedly too soon to draw conclusions about elections that will be held in almost six months.
This document is not pre-contractual or contractual in nature. It is provided for information purposes. The analyses and descriptions contained in this document shall not be interpreted as being advice or recommendations on the part of Lazard Frères Gestion SAS. This document does not constitute an offer or invitation to purchase or sell, nor an encouragement to invest. This document is the intellectual property of Lazard Frères Gestion SAS.
