Greece Will Muddle Through

CNNMoney, May 10, 2012. © 2012 Cable News Network. A Time Warner Company. All Rights Reserved.

The political stalemate in Greece has raised concerns that the nation is more likely than ever to leave the euro currency union.

But it may be too soon to say that the Greek government—once there is one—will decide that abandoning the euro is in the national interest.

Greece has been thrust into political chaos after last weekend’s elections failed to give any party a clear majority in Parliament.

The main concern is that the lack of leadership in Athens could jeopardize the nation’s bailout agreement with the European Union and International Monetary Fund. That could lead to a disorderly default by Greece, which would force the nation out of the eurozone.

As it stands, none of the main parties appear able to form a coalition government, which means the Greek president will have an opportunity to broker a deal. He too is expected to fail. That means Greece will likely hold a second election next month.

Paul Christopher, chief international strategist at Wells Fargo Advisors, does not expect the current political turmoil to result in Greece leaving the eurozone. He said the mainstream parties in Greece, which were punished by voters for supporting the bailout, might do better the second time around.

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“If the election fails to produce a coalition government, then the public fear of chaos may benefit larger, pro-European parties in a fresh election,” said Christopher. In any event, pro-euro parties control 67% of the Greek Parliament, he added.

Other euro area leaders have been ousted by voters frustrated with austerity—the policy of cutting spending and raising taxes to reduce public debts. But in many cases, the new governments have stayed the course.

“Spanish, Irish and Italian voters have already voted out governments that offered austerity, only to see the successor administrations offer more of the same,” said Christopher.

Meanwhile, the stakes are potentially huge for the rest of the eurozone.

There is still the danger that a default by Greece will drag down other troubled euro area governments, such as Spain and Portugal, despite beefed up crisis resources. In addition, the eurozone economy is fragile and any financial shock could plunge the region into a deep recession.

Given these risks, many analysts say EU authorities might be wiling to cut Greece some slack, although an outright renegotiation of the bailout program seems unlikely.

What’s more, EU nations and the IMF have already lent Greece over €100 billion and the European Central Bank owns some €40 billion worth of Greek bonds. In other words, Greece’s so-called official creditors have a significant financial interest in seeing the political drama resolved and a default avoided.

“There are many signals coming from European leaders attempting to keep Greece in the eurozone,” said Dimitri Papadimitriou, a professor of economics at Bard College. “I expect there will be some flexibility in meeting the targets for budget deficits.”

Much depends on how the newly-elected president of France, François Hollande, will interact with his German counterpart, Angela Merkel.

A long-time Socialist Party leader, Hollande campaigned against too much austerity and has promised to push through measures to boost economic growth. Hollande is expected to meet with Merkel, the most outspoken supporter of fiscal discipline in the eurozone, shortly after he is sworn in later this month.

“We first need to see how the dust settles in Athens and what Merkel and Hollande agree to before jumping to conclusions,” said Holger Schmieding, chief economist at Berenberg Bank.

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Gillian Edgeworth, an economist at Italy’s UniCredit, thinks EU leaders could allow Greece an extra year to push through fiscal reforms.

In a note to clients, Edgeworth said Greece is expected to build up a cash buffer of €5.2 billion, which could be used to cover budget shortfalls this year. In addition, the program assumes that Greece will pay down €9 billion in short-term debt this year and next, a portion of which could be delayed, she said.

“Though not huge, there is some scope for maneuver,” said Edgeworth.

On Wednesday, the directors of Europe’s bailout fund confirmed that Greece will receive an installment of €4.2 billion on Thursday. The European Financial Stability Facility also said it will disburse €5.2 billion from the first installment of Greece’s new bailout program by the end of June.

Officials from the EU, IMF and ECB—known as the troika—are expected to being their latest review of Greece’s bailout program next month. Greece is scheduled to receive its next installment of bailout money in August.