No longer unthinkable.

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Europe Needs to Cross Its Red Lines on Greece

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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Having "persuaded" Greek Prime Minister Alexis Tsipras to violate many of his Syriza party's red lines on austerity and privatization, the country's creditors must now breach some red lines of their own to assemble the financing Greece needs to carry out its policy reforms.

QuickTake Greece's Fiscal Odyssey

For the policy package to have any chance of success -- and the odds don't favor such an outcome -- Greece requires immediate bridge financing to reopen its banks, pay off arrears to the International Monetary Fund and meet a large payment to the European Central Bank on July 20.

These steps will need to be followed quickly by more external funding to recapitalize the banks and help counter the country's economic implosion. And the longer this funding is delayed by creditors, the higher the likelihood that the total bill will exceed the headline figure of 86 billion euros ($95 billion) attached to the bailout deal struck Monday.

The creditors' challenges aren't limited to providing the large amounts Greece requires. They also are hemmed in by the conditions of the assistance. Given its precarious economic and financial situation, Greece's external financing must carry highly concessional terms, including very low interest rates and very long repayment periods. It also requires significant further relief on the country's existing stock of debt, including outright forgiveness.

Greece and its creditors will have to fight three headwinds to mobilize this financing:

  • The lack of trust and mutual respect between Greece and its creditors: Not only does this complicate policy discussions, it also makes it difficult to reconcile Greece's need for immediate funding and the creditors' desire to pace and backload the disbursements to match Greece's success in implementing reforms. 

  • Burden-sharing issues among creditors: Given the deep uncertainty about Greece's capacity to repay its debts, individual creditors are unwilling to carry too much of the financing burden. They would rather see others lend more. This is particularly true of the ECB and IMF, which already have come under pressure from Europe to extend loans that far exceed the monetary institutions' normal mandates. The ECB knows that it will be called upon again to provide Emergency Liquidity Assistance to Greek banks, and that it will be uncomfortable acceding to the request (especially without a major recapitalization of the banks funded by others). For its part, the IMF -- to which Greece failed to make a second debt repayment this week -- has warned that it could walk away from the Greek package if the other creditors do not come up with sufficient debt relief. In an analysis released Tuesday, the fund said Greece's debt could only be sustainable through "relief measures that go far beyond what Europe has been willing to consider so far."

  • Funding instruments that are insufficiently flexible: Even if Europe's leaders were willing to meet the incremental financing Greece needs, they have only a limited range of flexible and unencumbered tools for doing so. Most of the financing possibilities require approval by national parliaments -- and Greece can only count on very limited sympathy.

The cumulative impact will be to aggravate the European creditors' unfortunate inclination to drag their feet, and they will try once again to shift more of the burden to the ECB and IMF. That carries the risk of further overt politicization that undermines the credibility and effectiveness of key institutions with important regional and global missions. Moreover, the IMF and ECB do not lend on concessional terms -- that is, under noncommercial conditions that make them much more favorable than market loans -- to countries such as Greece.

The probability that Europe will be willing to accept measures it has long resisted -- as Tsipras, the other architect of the latest agreement, was forced to do -- is low, adding to the contradictions and anomalies that the Greek tragedy will continue to produce and that prevent a quick resolution.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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