Not legal tender.

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Unraveling a Greek Drama

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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By signaling its on-again off-again willingness to make progress with its European partners, Greece has taken global markets on a roller coaster ride in the last 10 days, first helping to depress investor sentiment then boosting it. This is unlikely to end soon. Here is a Q&A on what you need to know.

QUESTION: Why is Greece a systemic problem?

ANSWER: Since Greece first became a threat to European stability and the well-being of the euro zone, the systemic effects of the crisis have spread from the financial markets to the political arena. Today, the concern is much less about the euro zone's ability to handle the economic and financial spillovers of a Greek exit (“Grexit”) and much more about the political demonstration effects.

Greece's Fiscal Odyssey

The conclusive election victory of Syriza 10 days ago reflects the growing popularity of nontraditional parties in Europe. These gains are driven by broad dissatisfaction after too many years of substandard growth and high unemployment. This discontent is directed not only at national politicians but also at the functioning of regional arrangements and, in the case of Greece, the leadership of Germany within the European Union. The implications include a potential threat to the established order in Europe.

With elections in Spain this year, European leaders are eager to demonstrate that even nontraditional parties such as Syriza end up adopting conventional policies once they understand the realities of governing. Should this shift fail to occur, some European leaders would rather see Greece be forced to disengage from the euro zone than have to change an approach that has been applied to other countries.

Q: What are the main issues?

A: The most immediate is the new Greek government's need to mobilize enough external financing to get through the next few months. Concurrently, it needs to make progress on defining an adjustment program that relies less on demand-side austerity and more on supply-enhancing reforms. And it needs to find a way to deliver on its promise to reduce the country’s debt burden as part of its pro-growth policy reset.

Q: Who are the main players?

A: The large number of parties makes the negotiations very tricky.

The Troika -- the European Commission, the European Central Bank and the International Monetary Fund -- has played the central coordinating role in the euro zone’s crisis management. In negotiating with Greece, it must be sensitive to the extent to which its decisions could serve as precedents for interactions with other euro zone countries in the future.

The new Greek government has said it won't deal with the Troika, but it will have no choice. That means Greece will have to take into account the positions of each Troika member's influential stakeholders.

Germany occupies a key role in the EU and, to a lesser extent, the ECB. Leading German politicians, including Chancellor Angela Merkel, have been less than enthusiastic in their response to the new Greek government’s rhetoric (which sometimes includes harsh criticism of Germany). They are also reluctant to see the ECB pulled away from its monetary functions and engaged in more quasi-fiscal activities. 

The IMF is sensitive to the view held by some of its staff and member countries, particularly from the emerging world, that European nations have exerted excessive influence on the terms of lending to the EU's peripheral economies. This is reflected not only in the amount of financing but also in the perceived failure of the IMF to insist on a large enough contribution from Greece’s European partners.

Q: How about private creditors?

A: Unlike earlier rounds, they may be the least important this time. Outstanding private debt has fallen, particularly in relation to Greece’s liabilities to governments, the ECB and the IMF. And private creditors have already participated in a meaningful round of debt reduction, or what is known as private sector involvement, or PSI. But private creditors shouldn't be completely free from worry about possible burden sharing this time around. No matter what the Greek government says -- and it has gone out of its way to reassure private creditors -- it is hard to see how private creditors could escape another round if there is deep debt reduction from some official creditors.

Q: What is the toughest part of the ongoing negotiations?

A: There are quite a few, starting with the immediate mobilization of funding. The ECB is understandably reluctant to allow Greece to access its balance sheet through large Treasury bill offerings in exchange for cash that the government could use to meet its domestic and external payments obligations.

Concurrently, Greece needs to find a way to stem the outflows of deposits from its banks. The longer these persist, the greater the risk they pose to the orderly resolution of the country’s challenges. This is the major Grexit risk element at the moment.

The Greek government also needs to devise a delicate rebalancing of its economic policy stance that will offset the relaxation of austerity with meaningful progress on genuine structural reforms. In doing so, it must strike a balance between the bold promises it made in its election campaign and the measures that would be acceptable to its European partners, the ECB and IMF.

Q: What is ahead?

A: Complicated and protracted negotiations. In other words, a continued roller-coaster ride for markets.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor on this story:
Max Berley at mberley@bloomberg.net