Greek Voters Provide a Respite for the Euro, but for How Long?

The outcome of Sunday’s parliamentary elections in Greece eliminates for the time being the worst-case scenario of a Greek debt default or a disorderly withdrawal from the euro, but the respite for Europe’s beleaguered currency may only be temporary.

Stock markets and the euro rallied after Greek voters, apparently heeding dire warnings from European leaders like German Chancellor Angela Merkel, narrowly backed the center-right New Democracy party at the polls. The party’s leader, Antonis Samaras, is promising to honor the commitments Greece made to its European partners and the International Monetary Fund as part of the $221 billion bailout deal agreed to in March, the second such rescue in two years. “There will be no more adventures,” he said. “Greece’s place in Europe will not be put in doubt.” 

(MORE: Is a Greek Exit from the Euro Zone Inevitable?)

The relief around Europe was palpable, and even Washington chimed in with its congratulations. “We hope this election will lead quickly to the formation of a new government that can make timely progress on the economic challenges facing the Greek people,” it said in a statement. European government officials and business leaders had been working on a variety of contingency plans had the election outcome been different. Treasury officials in several European nations say their greatest fear had been a possible run on Greek banks that could have provoked a wider panic across the continent. “This is more than relief. We avoided an immediate crisis,” says one top French banking official who could not give his name because of the nature of the talks. “We would have had a tragedy on our hands this morning.”

But as is so often the case in European politics, even this best-scenario outcome still has the potential to get messy. Three major challenges lie ahead for both Greece and Europe as a whole. The first — and most immediate — challenge is for New Democracy to form a workable government. The party won just under 30% of the vote and will have 129 members in the 300-seat Parliament. That means it will need to form a coalition, with the most likely partner being the center-left PASOK party, which won 12% of the vote and about 33 seats.

Samaras’ problem is that while New Democracy and PASOK broadly agree on the need for Greece to stay in the euro, they have been political archrivals for decades. Any coalition between the two parties, therefore, carries the risk of being unstable. Samaras addressed the potential problem in his victory speech on Sunday, saying that “we don’t have time for small-time politics” and calling for a government of “national salvation.”

(MORE: Euro Crisis: Is the Currency Finally Doomed?)

The antibailout Syriza party, led by 37-year-old firebrand Alexis Tsipras, won almost 27% of the vote and 71 seats in Parliament — meaning it will be a very tough and critical opposition party to the likely governing coalition. Tsipras emerged from almost nowhere in the past few months to become one of the leading political figures in the country thanks to his rejection of the austerity measures that accompanied the bailout. He is fiercely critical of both New Democracy and PASOK, which he blames for the mismanagement that led to the current mess.

Once a government is formed, the second challenge will be trying to forge an agreement on a modification of the rescue package itself. Merkel and other European leaders have repeatedly called on Greece to honor the commitments it has already made, ruling out a change in the terms. The country has agreed to four clear policy positions: “far-reaching structural reforms in the labor, product and service markets,” including a reduction in the minimum wage; massive cuts in public spending and a tax overhaul aimed at ending large-scale cheating; a recapitalization of Greek banks; and a big privatization program to sell state assets.

While none of these terms are likely to be substantially altered, European officials acknowledge it’s in their interest to at least make a political gesture to the new Greek government by way of encouragement. Guido Westerwelle, the German Foreign Minister, said on Sunday night that while the substance of the bailout agreement with Greece could not be renegotiated, he imagined “we could do something in terms of the time frame.” Euro-zone finance ministers said in a statement that they will send a team to Athens as soon as a new government is formed to “exchange views” with the country’s leaders “on the way forward and prepare the first review under the second adjustment program.” That’s cautious technocratic language that opens the way, at least in theory, for potential modifications.

The new Greek government will certainly have some potent ammunition it could use in these talks. It will likely point to the very strong antibailout vote in the parliamentary elections, warning that if the new leadership isn’t given terms more palatable to the Greek people, the alternative of a Syriza administration would be far worse for the euro zone. And in economic terms, the country’s next leaders are likely to stress that the Greek economy has actually been contracting faster than expected, making implementation of the agreed-upon cutbacks even more painful for the restless populace.

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Some analysts worry that this could reopen a Pandora’s box. Deutsche Bank analysts said in a note on Sunday that a partial renegotiation of the package could still ultimately lead to a Greek exit from the euro zone, albeit an orderly one, because of the dire state of the Greek economy and real doubts that additional doses of austerity will enable it to pull out of its current crisis. This is the fifth consecutive year in which Greece’s economy has contracted: gross domestic product dropped by 6.2% in the first quarter of 2012, according to national statistics, after declining by 6.9% in 2011 and 3.5% in 2010. Unemployment has also soared to almost 22%. It doesn’t help matters that the Greeks themselves have little confidence in their own future, judging by a high level of capital flight: an estimated $55 billion has been withdrawn from Greek banks in the past year alone.

The third challenge is perhaps the biggest one of all: finding a more sustainable solution to Europewide indebtedness and economic decline. The problems in Europe go far beyond Greece. Euro-zone finance ministers just last week had to step in with a $125 billion rescue package for Spanish banks after the Spanish government botched its handling of a savings and loans crisis. The ratings agency Moody’s cut Spain’s credit rating to one notch above “junk” status, and at one point, the nation’s borrowing costs rose as high as 7%. There have also been renewed jitters in Italy and Portugal, and it doesn’t help that there is a sudden bout of friction between Germany and France — the two key political forces in the euro zone. Merkel last week pointedly noted that France needs to examine its waning competitiveness, and others in her government have criticized new Socialist French President François Hollande, who made cutting the retirement age from 62 to 60 one of his first priorities in office. In Germany, the trend has been going in the other direction — Germans now retire at 67.

Working through such political differences at a time of high economic and financial tension was never going to be easy. Robert Zoellick, the outgoing head of the World Bank, warned last week of a European “Lehman moment” if things are not properly handled. For now, Europe seems to have dodged that moment with Greece, but that doesn’t mean there aren’t even bigger risks just around the corner.

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