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Greece: New Government, Old Problems

Confrontational – that is the keyword describing the new Greek government's course versus European Union (EU). While the risk of prolonged uncertainty has clearly risen, are outright default and euro exit likely at all?

The new government, led by the left-wing Syriza party, was sworn in on 27 January. Contrary to our hopes the first pronouncements and actions of the new government have been confrontational: it has re-affirmed its demands for (immediate?) debt relief, has announced that it intends to roll back some reform measures agreed with the Troika (IMF, EU and ECB) and has voiced vocal criticism of the current EU policy toward Russia. The rating agency S&P has already reacted by lowering the outlook for the B rated sovereign debt of Greece to "negative." The government haven't followed the statements with any concrete measures yet. For that reason it is impossible to judge to what extent the statements are intended to satisfy the voter base, or whether it will indeed renege on commitments made by the previous government.

Short-Term Liquidity Pressures

There is not much time left to come to an agreement with the Troika, as the current program of the European Stability Mechanism (ESM) and the European Financial Stability Fund (EFSF) formally runs out at the end of February 2015. Various important financial support measures or guarantees for Greece are more or less directly tied to the fulfillment of the Troika program.

  • The ECB has accepted Greek sovereign and state-guaranteed Greek debt as collateral in its standard liquidity operations, despite the "junk" rating of Greece. However, this exception is tied to Greece complying with the terms of the bailout programs.
  • Greece still has access to the ECB's Emergency Liquidity Assistance (ELA) program. The maximum amount of that program is reportedly around EUR 40 bn. However, it can only be granted to banks that are considered as solvent (albeit illiquid.)
  • Greece in principle has access to the so-called Hellenic Financial Stability Fund, which still could provide a further EUR 11 bn to recapitalize Greek banks if needed. However, these funds will have to be returned in the event that no agreement can be reached regarding an extension of the old program or the launch of a new one.
  • Profits from the ECB's old Securities Markets Programme (SMP) and the Agreement on Net Financial Assets (ANFA), i.e. capital gains and interest payments on Greek bonds bought by the ECB and Eurozone national central banks are transmitted back to the Greek government, but are at risk in case of non-compliance.
  • About EUR 7.2 bn are outstanding as disbursements to Greece from the current support program. This includes EUR 1.8 bn from the ESM/EFSF, EUR 3.5 bn from the IMF and about EUR 1.9 bn of profits from the aforementioned SMP and ANFA programs. These funds are unlikely to be disbursed if there is no agreement with the Troika regarding the continuation of the program.

Debt Amounts to 175 percent of GDP

The Greek government owes principal of slightly more than EUR 300 bn, according to Bloomberg data, or about 175 percent of the country's GDP. Of this, loans from the EFSF total around EUR 142 bn. The next largest share consists of bilateral loans from EU countries to Greece (EUR 53 bn). The IMF has agreed to lend EUR 32 bn to Greece and the ECB still holds about EUR 27 bn of Greek bonds. The remaining, largely privately held debt, sums up to about EUR 50 bn.

Explicit Haircuts Are Not to be Expected

Debt relief is in principle most unlikely to be applied on some of this debt because of the seniority of the creditor, and also due to political considerations. The IMF is a prime example: it generally does not accept haircuts on its loans. It is difficult to imagine that Greece would go so far as to not repay the IMF. The same basically holds true for the ECB's holdings of Greek debt; the ECB has made it clear it would also not accept a haircut. As such, only privately-held bonds and the official sector loans (EFSF and EU) remain. However, only a haircut on the latter would really make a difference in terms of real debt relief.

Implicit Debt Relief is an Option

The question is, whether there is much of a difference in practical terms for Greece given that the average maturity of the bonds is already high, i.e. there are no large redemptions for quite some time, and the interest rate burden is comparatively low. While there is still room for further reductions, instead of a haircut on the outstanding principal and the associated interest payments, the same relief on interest payments could also be achieved by extending the maturities and lowering the interest rates on outstanding loans even further.

Ultimately, this is a political decision that needs to be made. For the Greek government, "true" debt relief in terms of a reduction in the principal owed was an important promise made in the election. However, such a step appears to be unacceptable to creditor countries. While the possibility of extending maturities and lowering interest rates appears to be an attractive compromise, the negotiation process required to reach such a compromise may prove very difficult and prolonged.

Can Greece Wave Goodbye to the EMU?

If there is sufficient political will on the Greek side, it is hard to see why it should not be possible for Greece to leave the European Monetary Union (EMU) unilaterally. However, as the short-term costs appear very high, we do not consider it a realistic scenario. In a legal sense, there is no exit clause in the Treaty on European Monetary Union , and there are references in the Treaty that the conversion of the national currency to the euro is "irrevocable."

Legal considerations aside, leaving the EMU would ultimately be a political decision. The willingness and the ability of other member countries to effectively impose sanctions on the departing country would probably be limited. Given the huge collateral damage of a confrontational unilateral exit, the most likely outcome if Greece wanted to leave the EMU would be a negotiated exit, especially if it wanted to remain a member of the EU. That said, given that a Eurozone exit would certainly have to be a surprising unilateral move in order to avoid a bank run, negotiations are likely to happen only after the event itself.

Can Greece Be Shown the Door?

Greece cannot be expelled from EMU but could be "encouraged" to leave the union by changing the cost-benefit calculation of staying in the Eurozone versus leaving it from the Greek point of view (for example, by sanctions or a threat to cut off ECB liquidity to the banking system).

Even though some legal scholars argue that leaving the EMU would also mean leaving the EU, it is not that obvious. Retaining EU membership appears feasible if there is a broad political consensus among the other members that Greece should stay in the EU.