Elections in Greece on Sunday could throw the country into disarray once more, unsettling investors who believed that a deal struck earlier this year to restructure the country’s debt and avert a default marked the end of a major chapter in the euro zone debt crisis.
The outgoing Greek government has committed to harsh austerity measures in return for a second bailout by other euro zone countries and the International Monetary Fund, along with the debt restructuring, which saw private creditors take significant losses on their holdings.
Analysts expect a new pro-bailout government to come into power that will honor those commitments, but the new government will probably try to re-negotiate some of the points in the agreement it struck with the IMF in order to placate voters enraged by relentless wage and pension cuts.
“Part of the problem is that the Greek government appears to be running out of money fast. According to the IMF, it has gone back into arrears with suppliers, so the need for the Greek government to implement existing austerity plans and detail future cuts – in order to receive disbursements under the second aid plan – is acute,” analysts at UBS said in a note to clients.
“We believe that the new government will need to achieve this within a month or so of the elections if market turmoil of any kind is to be avoided, which seems unlikely in light of the election promises of the major parties,” they said.
The new government faces a daunting task: It needs to implement more than 3 billion euros ($3.9 billion) of budget cuts immediately and must outline an additional 12 billion euros in savings for 2013 and 14 under the bailout deal to bring its public debt around 117 percent of GDP by 2020.
Voting is mandatory for anyone aged 18 or over in Greece, and the latest opinion polls showed waning support for the two biggest parties, New Democracy and PASOK. They supported Prime Minister Lucas Papademos, a former central banker who took over from George Papandreou in November. Papandreou faced a backlash from European leaders when he decided to put new austerity measures demanded by the EU to the vote in a referendum.
Greece received a rare piece of good news on Wednesday when S&P upgraded the country’s credit rating out of default territory upon completion of the debt swap, but the ratings agency warned that Greece’s sovereign debt burden remained high.
“Greece’s general election should result in the formation of a new Government that is, on paper at least, committed to the terms of the recently agreed second bail-out deal. But with the economy still in freefall and public debt unsustainably high, the crisis in Greece remains far from over,” analysts at Capital Economics said.
European leaders’ and policymakers’ recent calls for greater emphasis on growth rather than austerity alone could help a new Greek government in seeking changes to the bailout terms and make the deal more growth-orientated, they said.
But given Greece’s poor record on meeting the conditions of its first bail-out, they would not be surprised if some core governments refused to sanction any changes to the deal. That would prompt tensions between Greece and the rest of the euro zone to build once again, Capital Economics said.
Capital Economics analysts think that the markets are correct to expect another major Greek default. “Indeed, we continue to think that Greece might yet default and exit the euro zone by the end of 2012,” they said.
But UBS analysts disagreed. “We have argued repeatedly in the past that a euro exit is not an option, and we remain very much of that view,” they wrote.
They argue that the economic consequences of a euro exit would be “disastrous” and that the gains from devaluation on return to the drachma are questionable.
“If the IMF does withdraw its support, it will likely become clear to Greek voters that without external support the situation will only get worse. We are inclined to doubt there will be a shift towards supporting an exit from the euro,” UBS said.
That view was echoed by Pawan Malik, head of Navigan Capital Markets Advisers who told CNBC there was little appetite for a euro exit in Greece.
“Once the dust settles and once they are in power, I think the coalition will realize the depth of what they face. And I suspect they will back down. Given the choice between dying today and dying tomorrow, I think they’ll choose to die tomorrow," he told CNBC.
“If you look for a real solution in Greece, then clearly the best thing would be for them to step out and sort their own mess out. But would they want to? I think that’s a different issue," he said.
That said, speculation about an exit could add to tension in the bond markets and could drive the country’s borrowing costs up again.
With 32 parties to choose from, forecasting the outcome of the election is tough, and although the two main parties are unlikely to be unseated, they have lost many supporters to anti-bailout parties. None of the parties looks set to obtain the 40 percent majority required to form a government alone.
“In the best possible scenario, the two main parties form a coalition with a majority of seats, quickly drop their pre-election pledges, execute promised spending cuts and detail a credible medium-term spending review, such that official payments are made as soon as June,” according to UBS. “But those are a lot of boxes to tick.”