El-Erian: Greece Can Learn from Brazil and Argentina

12/1/2015

By Mohamed A. El-Erian*

The possibility of an untested and extreme-talking left-wing party coming to power in the next elections sparks a sell-off in the markets. Creditors become nervous about the country’s prospects, particularly its exchange-rate stability and ability to service its debt. The leader of the party reacts by trying to paint a more reassuring picture of the future under a new government. But his attempts fall on deaf ears, risking self-fueling economic and financial dislocations.

Greece in 2015? No. That was the situation in Brazil before the October 2002 presidential elections, when Luiz Inacio Lula da Silva took a lead in the polls that ultimately translated into an outright win for his Workers’ Party. For many years until then, Lula had flirted publicly and privately with an alternative economic approach that would have involved large-scale debt restructurings and heavy reliance on statism to drive growth.

Expecting such an outcome, markets priced in a very high likelihood of a debt default. As bond prices plummeted, yields were driven to very high levels and Brazil’s market access almost disappeared. Bank deposits also came under pressure and the currency fell precipitously, placing further pressure on the country’s economic and financial stability. Steadily, Brazil approached a market-induced liquidity crisis that could turn into a solvency crisis that would derail the economy for many years.

In the event, the prices of all financial assets rallied as Lula adopted a relatively orthodox approach to economic management, in effect, delivering on measures he had detailed just before the elections -- a program that most investors either seemingly hadn't heard or refused to believe. In the ensuing years, the return of financial stability was accompanied by one of the strongest periods of economic growth and poverty alleviation, amplifying the return to investors.

As the latest polls show the anti-austerity Syriza party in the lead for the Jan. 25 elections, Greek markets are displaying some of the characteristics of Brazil in the second half of 2002. Sovereign risk, as measured by the spread on government bonds, has shot up, along with talk of possible debt restructurings and exchange-rate disruptions.

Moreover, attempts to calm markets by Alexis Tsipras, Syriza's leader, have, at least so far, mostly fallen on deaf ears for three reasons: Tsipras’ past rhetoric, a domestic political campaign narrative that includes potentially harmful references to Germany, and a bigger European phenomenon involving the rise of “non-conventional” political parties.

The underlying problem in Greece goes deeper, of course. It relates in an important way to a policy approach and an institutional setup that, despite major sacrifices by the Greek people, have failed to deliver growth, jobs and poverty alleviation. As a result, adjustment fatigue has intensified among citizens and the political class, with more unpredictable consequences for the country's future.

A euro zone exit (“Grexit”) is only one of these possibilities, though it hasn't been advocated by Tsipras for some time. Instead, he favors a renegotiation with Greece's European partners that would relax austerity policies and ease some of the terms on official debt, along with the provision of additional financing. These proposals are meant to place the country in a better position to implement the structural reforms needed to re-energize durable growth engines and create jobs.

This is where Brazil wound up after a particular rocky period in 2002-03. By developing a more sustainable and, therefore, more credible policy mix, it encouraged the re-engagement of both domestic and foreign investors. If Syriza wins the elections -- which is still highly uncertain --  a similar outcome might be available to Greece if the party follows a path similar to Lula’s, and if markets provide sufficient breathing room.

But Brazil isn't the only historical case from Latin America that is relevant to Greece today. The other is Argentina In December 2001, a mix of economic mismanagement and market disruptions forced it out of the exchange-rate arrangement that had hard-pegged its currency to the U.S. dollar. A cascading payments default followed, along with a deep recession, whose legacies continue to undermine the country. Indeed, Argentina should serve as a reminder to Greece of the importance of minimizing the possibility of an unprepared and disorderly exit from the currency union that would severely disrupt its financial relationships and seriously undermine the functioning of its economy.

As it prepares for a possible role in government, Syriza should be supplementing its emphasis on orderly economic management within the euro zone with behind-closed-doors work on the mechanics of an exit, should such an event prove inevitable. In addition to careful and detailed internal preparations for a Plan B for alternative exchange and payments regimes, this would require clear communication of an alternative economic vision for the country. It would also require early coordination with European partners, including a quick pivot to some variant of an EU Association Agreement that would continue to provide preferential access and interaction with the union for Greece.

* Chief economic adviser at Allianz SE. He’s chairman of Barack Obama's Global Development Council, the author of best-seller "When Markets Collide," and the former chief executive officer and co-chief investment officer of Pimco.

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