The Third Greek Test

Greece has twice provided the acid test for the rules of the game of the European monetary union. Once again it is likely to provide a critical testing ground, this time on the occasion of the general election on January 25.

The first test came in spring 2010, when the government in Athens lost market access and required assistance from the European Union and the International Monetary Fund. The question then was: Can official support be provided to a member of the monetary union, and if so, by whom? The EU treaty was remarkably ambiguous on the issue. Many read it as implying that there was no room for official European assistance because it would violate the so-called no bail-out clause. But in the end the heads of state and government decided to extend conditional loans to Athens alongside the IMF, giving birth to the now famous (or infamous) troika. The same template would apply later to Ireland, Portugal and Cyprus, without giving rise to legal challenges.

The second test came in 2011-2012, when it became evident that Greece's debt burden was too high and that some sort of relief from its private creditors was indispensable. Could a member of the monetary union renegotiate its debt while remaining in the euro? Here again, the treaty was remarkably silent and there was no procedure whatsoever for debt renegotiation. For months, a fierce battle went on in Europe. Most European officials claimed that a restructuring by a euro-area country was unthinkable, and that Greece had no choice but to repay or, for some, to leave the euro. But in the end – and actually at a late stage, after many private creditors had been repaid in full – European leaders decided that debt relief was acceptable. In February 202, Greece reached a debt reduction agreement with its private creditors.

The general election provides a third test. If the opinion polls are correct Syriza, the radical left party, is ahead of the ruling New Democracy party. This means its leader, Alexis Tsipras, would be asked to build a governing coalition. According to its program, Syriza stands for a renegotiation of public debt resulting in a cut of its nominal value – currently more than 300 billion euros or 175 percent of GDP – and in the conversion of the remaining stock into some form of GDP-indexed bonds, so that repayments are made dependent on economic growth. The party also calls for emergency social spending, tax relief for the middle class, the full repeal of the 22 percent minimum wage cut implemented in 2012 and of other key Troika-inspired labor market reforms, and political reform.

For the EU, this perspective first raises a financial issue. When Greece renegotiated its public debt in 2012, it was with its private creditors. The official lenders, meaning the IMF and the euro-area member states, were not affected. The debt restructuring – the largest ever – resulted in a more than 60 per cent haircut and creditor losses amounting to 100 billion euros. This time, however, any debt renegotiation would hurt the official creditors, for the simple reason that there are barely any private creditors left. Furthermore, the terms of European official lending to Greece have already been softened considerably. Athens benefits in full from the European lending facility's favorable borrowing conditions and the average maturity of loans is 32 years. This is as far as official creditors can go without admitting that loans financed by taxpayer money are not going to be repaid.

But the 2012 restructuring notwithstanding and despite the fact that from 2008 to 2013 Greece implemented a fiscal adjustment amounting to 16.5 per cent of GDP, mostly through cutting spending, the debt to GDP ratio at the end of 2014 was higher than at the end of 2011, shortly before the restructuring took place. In its latest review of the Greek program, the IMF has warned that "the political commitment to the debt strategy will be severely tested going forward" and that it was essential for European partners to stand "ready to provide the additional relief needed to keep debt on (its targeted) path". It has sympathy for the idea that the Greeks can be forgiven for suffering adjustment fatigue. But despite having lent in parallel to the EU, the fund itself does not intend to participate in any relief. Oddly, it merely suggests to Europeans states to bear the burden alone. German Chancellor Angela Merkel, French President Francois Hollande and their fellow leaders would have to turn to national taxpayers and hand over the bill. They are understandably less keen.

The other issue is political. While Syriza's program is in part compatible with the Troika's demands – especially as it intends to get rid of the tax and competition privileges of the Greek business oligarchs – it is in several respects in stark opposition to them. The rise of the minimum wage, the repeal of labor market reforms and the hiring of civil servants, to name just three measures, would amount to a policy U-turn.

Some European leaders reacted to the possibility of a Syriza victory in a disputable way. In December, European President Jean-Claude Juncker said he would prefer to see "familiar faces" remaining in charge in Athens and was accused of putting pressure on the voters of a politically sovereign country. The German press also reported that Merkel would be playing hardball and might even consider a "Grexit" from the euro area – remarks that were later denied.

The issue is very serious because it amounts to determining the scope for autonomous policy choices within monetary union. It is also a novel one because European governments of the left and right have so far been willing to comply with the EU policy requirements, or at least not to challenge them openly. What will happen if a Syriza government breaks ranks? In principle, it depends on whether it puts into question requirements that have been enshrined in EU treaties and have constitutional status, or merely adopts a different policy course while staying within the realm of the constitutional framework. But a radical government might challenge the prevailing separation between constitutional and non-constitutional politics and call for a broadening of the scope for legitimate political decision.

If Syriza wins, there will certainly be room for discussion between the new government and the Troika. But if a confrontation over the scope for political decision arises, who prevails will be crucial politically and financially for the future of the European monetary union. Too tight a straightjacket would likely result in the EU being accused of denying the Greek people the right to democratic choices. It would certainly trigger a political backlash and diminish support for the European monetary union. But excessively loose constraints would frighten financial markets, showing them that the fiscal discipline and reform commitments entered into by governments are worth little, and they would antagonize the fiscal hawks in Germany and elsewhere. Which balance will be found will therefore be of major importance.

The rules of the game for the future of the euro are likely to be written in the weeks to come. The third Greek test will not be any easier to pass than the first two, to say the least.

Jean Pisani-Ferry teaches at the Hertie School of Governance in Berlin and serves as commissioner-general for Policy Planning in Paris. He is a former director of Bruegel, the Brussels-based economic think tank