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20 February 2015

Greek tragedy or bright future?

Will the Greek Fiat 500 insist on crashing head-on into the 50-ton tank – losing the game of chicken?

The stand-off between the Greek Government and the Eurozone is heading into its final stages. The liquidity situation of both Greek banks and Government is becoming critical so they must strike a deal that the Greek side can deliver in its Parliament – or adopt a radically different course.

The ECB has just raised the ceiling for ELA by €3.3 billion and that may have been calibrated to last to the end of February – only a few days away. It seems that tax revenues are falling short of expectations as the offer of settling arrears over 100 months has produced the entirely-foreseeable result that citizens have awarded themselves a period of grace before making any payments.

Any failure to agree a deal by the end of this weekend must surely raise the spectre of a depositor panic that will be difficult to stop. The obvious solution thereafter is for the Central Bank to use its powers to impose a “bank holiday” while the Government puts bills through Parliament to impose administrative controls on withdrawals from banks in Greece. Such a step only needs permission from the Commission and not the Member States. 

Bank subsidiaries and branches outside Greece: At end-2014, Greek banks had non-bank funding of about €34 billion outside the euro area. There are branches and subsidiaries in both London and New York so the authorities there must be quite nervous about the fate of depositors under their protection. Aggregating bank and non-bank deposits, they seem to be about €10 billion larger than the assets.  It is reasonable to expect these authorities to take early and swift action to take operational control if the deposits are at such obvious risk.

The potential losses faced by the ECB on its lending to Greece are substantial. Yesterday, it reported a profit for 2014 of just under €1 billion so that seems quite small against the €18 billion of Greek bonds in the SMT programme and the new ELA limit of €68 billion. ELA was twice this level at the peak of the 2012 crisis BUT a programme had been agreed and was being implemented. The current situation is very different as the newly-elected Government is resisting arriving at an agreement that convinces its partners that it will remain credit-worthy.

So the ECB is running a real credit risk as the Central Bank of Greece has only about €25 billion in gold and securities. However, the European Central Bank is not actually a bank in the sense of being an authorised “credit institute” under EU banking legislation. It is an EU institution set up by the Treaty so does not need capital. A commitment from governments to provide any necessary funding in due course would be sufficient.

What impact on the Eurozone? Other programme states have emerged and are performing strongly economically.  Ireland, Portugal and Spain are expected by the Commission to grow significantly faster than the eurozone this year – with Ireland twice as fast. A similar outperformance is expected in 2016.  Tragically, Greece was expected to be in the same bracket as Ireland but the current crisis has probably killed off such hopes.

These three states have exited from their programmes with full access to long term financial markets e.g. Portugal sold €2 billion of 30 year bonds last month with orders for a huge €14 billion. Moreover the ECB is a few weeks away from launching its massive QE programme and few investors would wish to short bonds against the `printer of euro’ who will buy and then hold the bonds to maturity. Such shorting would be a sure path to ruin. Commentators talking about the risk of contagion seem to be stuck in a time warp from three or four years ago.

It is possible to argue that contagion-free problems for Greece can be used by many politicians around the euro zone to illustrate the benefits of prudent fiscal policies and a functioning market economy. As France, for example, struggles to liberalise its economy, Greece stands as a dreadful warning of the long-term results of avoiding the necessary steps to make an economy competitive again. The reminder may be particularly forceful at this stage of the European Semester when Member States are having their budget proposals scrutinised to ensure that the plans realistically put them on track for fiscal prudence.

However, the Greek case also carries existentially high stakes for the eurozone. If the Finance Ministers agree a weak arrangement that does not actually crystallise, let alone be fully implemented, then why would any state in the future worry about the entire panoply of the new economic governance arrangements when the minsters have caved in at the final moment and disbursed their taxpayers’ funds freely to whoever shouts vague promises loudly.

The credibility of the Syriza government is very weak as it is all too apparent that they promised electors actions that any analysis at the time would have shown to be very difficult to achieve. Did they do that analysis thoroughly beforehand? Even now, have they really analysed the situation that could materialise as early as next week? That may not suit `game theory’ professors but they must surely have been given a crash course in how the financial system actually works in all its practical details. Does 36% of the vote really entitle Syriza to drive 100% of the electors into a spectacular `car crash’ with the economic equivalent of a large tank?

Scenario I: Staying in the euro

Syriza says it wants to stay in the euro – as do 79% of the Greek people in the most recent Eurobarometer poll. Without an agreement with the eurozone next week, the Greek banking system is likely to enter a critical period for its liquidity and a `bank holiday’ would be highly likely. With lower than expected tax receipts, March would be a very difficult month for the government’s own cash flow.

The Government could nationalise the banks by purchasing all the shares. However, the Single Supervisory Mechanism (SSM) would need to be satisfied about the on-going solvency and a crashing economy could put the value of many assets at even greater risk. Perhaps the Greek resolution authority could strip the payments system components out of the banks and run it as a public utility. But how long would it be before the `bank holiday’ on payments could be lifted? What would that do to the economy?

Scenario II: Leave the EU

Greece could free itself from the shackles of the SSM and eurozone programme obligations instantly by leaving the European Union. It could re-apply, or ask to join the EEA instead. But that would all take time – probably years - and in the interim, Greece would have to deal with trade relations around the world. That would include the banking authorities in the US and UK – where EU passporting rights would be lost immediately. All disbursements from the EU for structural funds, agricultural payments, EIB loans etc would cease. In 2013, Greece received inflows of about 2.9% of GDP from the EU budget alone. Tourists would face extra checks in visiting Greece rather than say Italy, Spain or Portugal.

Scenario III: A bright future

Greece can offer the eurozone (and the EU as a whole) several non-economic benefits that would make a generous financial settlement worthwhile when seen as a grand bargain. But that would only be the case if the eurozone can be confident of delivery of the promises. The Syriza government has a mountain to climb to establish credibility so disbursement of funds is only likely against measured achievements. Several items come to mind: rapprochement with Turkey, resolving both the Cyprus and FYROM problems. Supporting the tough EU line on Russia to show solidarity with the states on the Russian borders would also be appreciated.  The Baltic States may soon be under threat yet they have minimum wage levels around 40% of Greek levels and have still guaranteed large amounts of loans to Greece.

What more could the eurozone do`in return’ for Greece becoming a fast-growing modern market economy (thus fulfilling the reform elements of the programme) that is also a full, team player: (i) the ESM could buy out the ECB’s €18 billion of bonds – thus relieving immediate cash flow pressure this summer - and then grant the same 10-year interest/capital repayment free terms that have been given on the main EFSF loans. (ii) If things went very well, the ESM could even buy out the IMF loans and give the same generous repayment terms.

But Syriza has now forced itself into a position where it will have to swallow a huge dollop of its own personal pride – let alone that of 36% of Greek electors – to get a deal that would be massively to the longer term benefit of 100% of Greek electors. Can it even get a Parliamentary majority to enact the necessary laws in time to avoid the crash?

The answers may be clear by Monday morning.


© Graham Bishop

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