* Beyond the pre-election rhetoric
We discuss the main conditions that we think any new Greek government will have to meet in order to avoid tail risks. We argue that there is room to improve Greece's adjustment program, but that this will depend to a large extent on the political will to implement key reforms. Our baseline is that the government that will follow the elections of Jan 25 and the Troika will have strong incentives to avoid extreme outcomes. However, we expect very difficult negotiations that could trigger more market volatility, while risks could remain high for most of the first half of the year.
* Key conditions for a positive outcome
• The elections of January 25 need to lead to a government, most likely a coalition. Failure to do so is expected to lead to a second election in early March, prolonging the uncertainty. Formation of a one-party government could also be a negative outcome, as its slim majority could be fragile.
• The new government will have to show very quickly a strong commitment to reach an agreement with the Troika. This is necessary for the rest of the Eurozone to extend the current program beyond February, to provide time for negotiations and allow the ECB to continue funding the Greek banks.
• Any agreement with the Troika will likely have to find common ground that will be politically acceptable both in Greece and in the rest of Europe. The new Greek parliament will have to approve a deal that will most likely differ from a
number of pre-election promises. The Eurozone parliaments will also need to approve a deal that will provide more help to Greece, but subject to credible conditions.
* An ideal deal
Greece has strong negotiating power within a program with the Troika, as more than 80% of its debt is with the official sector. However, Greece loses its negotiating power if the government is not willing to implement the key reforms in the program. In an ideal deal, Greece will likely continue with (hopefully less) fiscal consolidation and (hopefully more) reforms, in exchange for further support from the Troika (in the form of a conditional credit line if market conditions improve), ECB bank liquidity support and (hopefully) QE participation, and (hopefully soon) an OSI. We believe
that the primary surplus target will be the focus of the negotiations, which will then determine everything else—reforms and the size of the OSI.
* Could Tsipras be Greece’s Lula?
We discuss the case of President Lula in Brazil, a former union leader from the left, who proved market concerns unfounded and was credited with impressive economic performance. Lula’s case suggests that Mr. Tsipras could similarly surprise markets positively by accelerating market-friendly, structural reforms.