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Jun 27th 2015

An incoherent proposal from the Greek government opens a new chapter in the crisis

"THE crisis has commenced," declared Michael Noonan, Ireland's normally mild-mannered finance minister, as he left today's Eurogroup meeting in Brussels. It is hard to disagree. One week ago Greece-watchers were wondering whether Alexis Tsipras's left-wing government could strike a deal with its creditors in time to unlock the bail-out money it needs to avoid defaulting on a €1.5 billion ($1.7 billion) IMF payment due on June 30th. It is a sign of how quickly matters have deteriorated in the last 24 hours that the IMF bill, which will now surely be missed, is now a sideshow. Instead, after Mr Tsipras unexpectedly called a referendum over the creditors' latest offer, the question is whether there is still a place for Greece inside the euro zone.

On July 5th, assuming Mr Tsipras's plan holds, Greeks will vote on whether to approve a set of reforms and fiscal adjustments proposed last week to Mr Tsipras's government by the creditor institutions (the European Commission, European Central Bank and IMF). Announcing the referendum last night, Mr Tsipras made his own view clear. The creditors' offer, he said, proved that "certain partners and members of the institutions are not interested in reaching a viable and beneficial agreement for all parties, but rather the humiliation of the Greek people." After Mr Tsipras's speech Greek ministers fell over each other to say they would recommend a "no" vote.

Mr Tsipras's declaration seemed an acknowledgement of something his government has long denied: that Greece must choose between the creditors' path of austerity and leaving the euro. But it raises more questions than answers. After having insulted his euro-zone partners last night Mr Tsipras said he would ask them for a "short extension" of Greece's bail-out, which expires on June 30th, to cover the period of the referendum. At their meeting today, finance ministers outright rejected that suggestion. Without a radical change of direction from Mr Tsipras, therefore, the bail-out will expire on June 30th, along with €16.3 billion in potential bail-out support, and Greeks will be voting on a defunct proposal. The meaning of a "yes" vote will be impossible to divine.

Speaking about this after today's Eurogroup Greece's loquacious finance minister, Yanis Varoufakis, lapsed into incoherence. The ministers' refusal to countenance an extension of the bail-out, he said, caused "permanent damage to the credibility of the EU". Why? Because there was a "very high probability" that the Greek people would spurn the government and support the creditors' proposal. Greece, Mr Varoufakis seemed to be arguing, deserved yet another extension of its bail-out to give the government time to advise voters to reject its terms, because that advice might well be rejected.

Such sophistry aside, Greece now faces two urgent challenges, one financial and one political. The first problem is Greece's banking sector, which has been haemmorhaging deposits in recent weeks. The governing council of the ECB, which has been keeping Greece's banks afloat via an emergency liquidity assistance (ELA) programme, will convene tomorrow morning to discuss its support. After today's developments most observers think Mario Draghi, the bank's president, will have to place a cap on ELA, which stands at €89 billion. With up to €1 billion having been withdrawn from Greek banks today alone, that will surely oblige Greece's government to impose capital controls this week. Greek depositors drew as much cash as they could from ATMs on Sunday amid fears that capital controls would be imposed by Monday. Long lines formed outside bank branches in Athens and provincial towns from early morning. A statement from the Eurogroup today came close to recommending such a move. "This is a immediate problem, not only because the banks are depleted of collateral for ELA but also because the banks' non-performing loans are skyrocketing now that the economy has dipped back into recession," says Megan Greene, chief economist of Manulife Asset Management.

Mr Tsipras's second challenge is to think through the consequences of his referendum. Having denounced the creditors' offer to Greece in such scathing terms, it is hard to see how he can stay in office if voters back it. Mr Tsipras has been under intense pressure from the extreme left wing of his Syriza party not to give ground to creditors; some backbenchers have threatened to bring down his government if a deal is put to parliament. Mr Tsipras would face humiliation if it passed thanks to support from pro-Europe opposition parties. "The Greek government is asking for a vote on a deal it has not the courage to finalise," said George Papandreou, a former premier who was forced to resign in 2011 after proposing a referendum on Greece 's continued membership of the euro. But Syriza, with or without Mr Tsipras at its helm, is far ahead of any rivals in opinion polls and may well be returned to office if snap elections were called. That would leave it in the awkward position of having a mandate to restart negotiations with its creditors on a new bail-out presumably based on conditions that it has already rejected.

A "no" vote, on the other hand, would set Greece on a dangerous path that could lead to Grexit. With no source of financing its default on the IMF would be followed by a further missed payment, to the ECB, on July 20th. That would presumably oblige the ECB to declare Greece in default, and to withdraw its ELA entirely. Banks would collapse, and to pay salaries and pensions Greece would have to turn to alternative forms of payment, perhaps beginning with IOUs or informal "scrip" currency. The exit door from the euro would be wide open. Mr Varoufakis points out, correctly, that there is no legal mechanism to eject Greece from the euro zone. But if his government continues down its current path, it may find that the law is of little help. Greece's options have narrowed. After today's failed talks with Mr Varoufakis, the Eurogroup moved on to discuss "Plan B"—what to do about Greece in the event of a rupture. In a heated phone conversation with Mr Tsipras last night Angela Merkel, Germany's chancellor, is reported to have told him that his referendum would amount to a vote on Greece's euro membership. That may or may not turn out to be accurate. But it shows how close to the brink Greece has come.