Friday, 6 February 2015

Two games of chicken: Ukraine and Greece

In addition to the game of chicken being played regarding Greece's debt restructuring and its future in the Euro monetary system, another one even more tragic is being played over Ukraine.

Let's analyse the two problems which are so serious that it is very improper to call them games as they both involve people's destiny and choices between life and death.

Let's start with Ukraine:

What Ukraine wants:

  • To safeguard its territorial integrity and have safe borders with neighbours
  • To live at peace with its neighbours including Russia
  • To adopt a long term plan to integrate itself within the EU and with the West via NATO membership.
What Russia wants:
  • To keep Ukraine within its sphere of influence
  • To take full control over Crimea where it holds a strategic Russian military base
  • To protect the interest of ethnic Russians in Eastern Ukraine
  • To keep Ukraine out of NATO and the EU and keep it as a territorial buffer between Russia and NATO countries.
What the West wants:
  • To extract Ukraine from Russian sphere of influence
  • To safeguard Ukraine sovereignty and their ability to decide their own destiny
  • To extend NATO to Russia's border
Obviously many of these objectives are conflicting and as a consequence Ukraine is gradually slipping into a proxy war between the West and Russia.  Russia is clearly supplying arms and resources to ethnic Russians in eastern Ukraine to help them overcome Kiev's determination to impose its sovereignty over the region.   The West is now considering supplying arms to Kiev to protect the integrity of their sovereign territory.  This inevitably causes escalation possibly leading to a full scale conflagration.

The West is escalating sanctions over Russia in the hope these would force Russia to scale back its hostility towards the Kiev government,  but sanctions normally do not work at all, and if they do, they take a long time.  On the contrary sanctions are helping Putin to maintain his popularity at home and cover at a lot of his faults by blaming sanctions by the West that  are depicted as Western tools in their bid to dominate Russia.

A possible compromise has to include the following:

  • Ukraine's sovereignty has to be restored over all its territory including Crimea.
  • Crimea is to be leased on a very long term basis to Russia as China had leased Hong Kong to UK
  • Ukraine is to adopt a constitution that gives substantial political and economic autonomy to its Eastern Regions
  • Constitution has to provide that any decision for Ukraine joining NATO has to be approved by a UN supervised referendum and in any case NATO will not breach the autonomy given to the Eastern regions.
  •  Borders between Ukraine and Russia are to be supervised by UN international peace keeping force.

And now to Greece.

What Greece wants:
  • Renegotiation of all agreements which will involve substantial easing of Greece debt load 
  • Respect for their fiscal autonomy 
  • Restructuring with emphasis on economic growth rather than crushing internal demand
  • Investments to promote increase in Greece economic capacity
What the EU wants:
  • Respect of all agreements signed with previous Greek government including austerity measures and privatisations.
  • Negotiation of renewal of the austerity package beyond February 2015 as Greece has no real possibility of otherwise financing themselves on the capital markets.   This may involve further conditionality.
  • Greece to perform substantial economic restructuring needed particularly involving fiscal enforcement and tax collection.
These positions are obviously conflicting and if no compromise is found Greece will default on its debt leading to it being forced out of the Euro if not altogether out of the EU.   Neither Greece nor the EU want a forced exit out of the Euro which could have unquantifiable and severe unintended consequences which could be as big as Lehman's default in 2008.   In fact the risk of GREXIT ( Greece exit form the Euro) is the most effective, probably the only, negotiating tool that Greece has in conducting negotiations with the EU, Germany in particular.

So ultimately it seems we are heading towards an ominous game of dangerous brinkmanship.    It need not and should not be so. 

Let us list the points that everybody seems to agree upon, or at least should agree upon, and around which some sort of compromise could possibly be built:

  • Greece needs to restructure their economy and make it competitive and sustainable not so much for the benefit of their creditors but mostly for their own sake.   There is no future in playing the desperate role of bringing the roof on all if Greece is not allowed to continue living their means.
  • Greece cannot sustain a debt of 175% of GDP and some sort debt easing is absolutely necessary as a quid pro quo for Greece doing what really needs to be done to restructure their economy.
  • Euro countries and Euro institutions that lent money to Greece cannot and should not take a loss on their loans to Greece.
This seems like squaring a circle but in fact it can be done with some flexibility and creativity and not only for Greece but for all countries for a portion of their debt which exceeds 100% of their GDP:

  • All direct bilateral loans and the bonds held by the ECB are to be refinanced at original cost by the ESM
  • ESM is to finance this by issuing zero coupon long term bonds which will be acquired by ECB through their QE operations.   Better to focus QE on such measure rather than buy bonds of countries who do not need any Central Bank buying their bond ( e.g. Germany and Malta)
  • The refinanced bilateral loans to the extent that they reflect excess of debt to GDP over 100% are to be converted into long term contingent coupon bonds with coupon linked to GDP performance.   Such contingent coupon bonds are to carry warrants that in case of non-respect of warranty conditions the bonds will become repayable on demand.
  • As further incentive, linkages are to be made where the higher the contingent coupon payable ( reflecting success in economic restructuring leading to economic growth) the more investment is to be allocated to Greece under the Juncker Plan and its successors or extensions.
  • Euro countries with strategic surplus in their Balance of Payments are to be compelled to pay non-refundable contributions to a contingency fund within the ESM to build a reserve against possible loan losses.  This is in recognition that surplus members are gaining advantage through their Euro membership which they would not have gained if they had maintained their national currency.
There is space for a good and sustainable compromise after the parties get tired playing their  dangerous games of chicken.

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