|The stand-off between Greek finance minister Yanis Varoufakis (right) and Wolfgang Schäuble, his German counterpart, at a farcical press conference on Thursday|
Markets are convulsing amid a dangerous game of brinkmanship between northern European creditors and the new anti-austerity administration in Greece.
The European Central Bank (ECB) announced on Wednesday it would no longer allow Greek banks to use their country’s bonds as collateral to access direct ECB financing, citing uncertainty over the continuation over the bailout programme with international creditors.
The move leaves the emergency liquidity assistance (ELA) – an indirect form of financing via the national central bank – as the principal form of liquidity assistance for Greek banks.
A farcical press conference on Thursday concluded with a stand-off between Greek finance minister Yanis Varoufakis and Wolfgang Schäuble, his German counterpart, revealing the divide between the two countries over the how to tackle the twin challenge of financing Athens in the near-term and relieving its outstanding debt stock.
Amid fears over the Cyprus-like introduction of capital controls to stem capital outflows, Greece is in desperate need of bridge-financing before its programme expires at the end of February.
One London-based European bank analyst says though the ECB decision on Wednesday was technical, there is now a material risk of Grexit, adding: “At one level the ECB’s announcement is a technicality – the ECB will still fund Greece just through the back door [ELA] rather than through the front door [MRO].
“This is a giant game of chicken. There are still a lot of deposits in the Greek system. But deposits are the transmission channel through which accidents can happen. The risk of Greece exiting the eurozone by accident is between 1/10 and 1/5.”
Varoufakis has said the government will present a detailed debt-restructuring proposal by the end of February with the aim of securing a new deal by June, citing Greece’s solvency, rather than liquidity, challenge.
This could include proposals for ECB-owed debt to be converted into perpetual bonds – a proposal the ECB has already rejected – and GDP-growth-linked swaps to official creditors, except the ECB, among other initiatives. Germany reportedly expects negotiations to drag on until May.
|This is a giant game of chicken. There are still a |
lot of deposits in the Greek system. But…
European bank analyst
Charles Dallara, who was in charge of coordinating private-sector creditors in his capacity as head of the Institute of International Finance, a bankers’ lobby group, successfully spearheaded the Greek private sector involvement (PSI) in 2012, the biggest sovereign debt restructuring in history.
This saw around €100 billion of write-downs, equivalent to a 53.5% face-value loss on Greek bonds, avoiding the taboo of the IMF and ECB taking write-downs, and, in the process, triggering the mother of all rallies in Greek credit until the new administration assumed office in January.
The latest Greek crisis highlights the failure of that bailout to generate a sustainable debt profile and a palatable fiscal policy, resulting in the failure of the previous administration to claim ownership of the rescue package to defend it in the court of public opinion.
In an interview with Euromoney, Dallara says the troika – the European Commission, the IMF and the ECB – should relax fiscal targets for Greece, and the IMF should lower interest rates on bailout loans. In addition, the ECB should provide ample liquidity assistance for the banking system, as well as recycle its profits on Greek debt holdings to policymakers in Athens.
“Why now fixate on the debt issues?” says Dallara. “The question is how to generate higher nominal growth. The question is how to re-orientate the package from the belt-tightening measures, which proceeded at a too-rapid pace and became self-destructive. Athens should have more say in the design of the programme.”
In turn, Athens should accept that debt-to-GDP targets underscore the need for a medium-term growth plan rather than serving as a benchmark to calculate desired official-sector losses, Dallara says. This bargain should be sweetened by the re-profiling of sovereign debt in favour of longer maturities and structural reforms, giving Athens counter-cyclical fiscal space.
On ECB support, Dallara, now the executive vice-chairman of Partners Group, a global private equity firm, adds: “Greek banks are vulnerable, not because of mismanagement, but because their capital base is being eroded due to sovereign fears. There is a material risk of destabilizing the Greek financial system and Greek banks merit support.”
Private-sector holders of Greek debt in 2012 grumbled that the troika – emphasizing the 120% debt-to-GDP ratio benchmark – kept their bailout contribution hidden throughout the PSI negotiations as a means to force private creditors to accept greater nominal losses.
In any case, this strategy spectacularly failed. Greece’s debt to GDP was an eye-watering 175% of GDP at the end of 2013, higher than the 170% before the haircut, and 157% immediately after, thanks to the negative-growth impact of massive spending cuts and tax hikes, now dubbed the biggest fiscal contraction over a three-year period for an advanced economy in modern history.
Dallara says: “I have never seen so many repeated rounds of fiscal austerity that left the economy to contract by 25%. The IMF started this programme and should realize it was wrong-headed. The obsession with debt sustainability is counter-productive.
“I really think Greece is right to ask for more fiscal flexibility, but it’s not going to grow if it rolls back on structural reforms, else it will slide back to the oligopolistic economic structure.”
Northern European creditors staunchly oppose Athens’ call for a debt write-down, which, at around 90%, is largely owed to official creditors, three-quarters of which are owed to eurozone countries, the ECB and the IMF.
The jury is divided over debt sustainability in the near- to medium-term. While the average maturity of debt is over 15 years and interest payments equivalent to 4% of GDP – in other words, a longer maturity and lower rates relative to the outstanding debt stock than most eurozone nations – Greece argues the debt overhang imperils economic growth.
It also argues that a soft de-facto haircut for the public sector – through lower interest rates and extended maturities – won’t bridge the financing gap, especially if growth disappoints, or materially adjust the outstanding debt burden.
A research note last year by the German Institute for Economic Research (DIW Berlin), which backed GDP-linked bonds for Greece, argued debt-restructuring in the near-term is a do-or-die affair to give Athens fiscal breathing-room.
“First, up until 2023, Greece only has to pay interest to its European creditors on loans from the GLF [Greek loan facility, the bilateral loans to Greece from the troika],” it states. “Therefore, this provides the only possibility for an imminent and direct reduction of the interest burden.
“Second, maturities are already long, and the first repayments are not due until 2020. Consequently, a maturity extension or a later start of the redemptions would have no direct effect on the interest burden in this decade.”
In 2013 alone, Greece was required to pay 4% of GDP on interest payments, and a primary surplus of 3% to 4% over the next seven years could be on the cards to meet bailout targets, DIW Berlin calculates.
A Greek GDP warrant has the potential to stabilize its debt burden and debt-servicing costs even if its growth remained weak – providing fiscal relief – and to incentivize reforms.
While Argentina has offered GDP-linked loans to the private sector, and a similar warrant was offered in the 2012 Greek PSI, there is no history of the official sector fundamentally restructuring the net-present-value terms of its claims through such a mechanism.
Dallara cites the challenge of convincing the official sector to provide new money to Greece while incurring immediate face-value losses.
“We forget that the Paris Club has existed for decades and they have found ways to restructure sovereign debt, typically without involving nominal haircuts,” he says. “The nature of official lending differs from private sector as debtors typically need new credit extended from official creditors.”
Nevertheless, the Brady era demonstrated that banks have historically offered fresh money to new clients, even as loans got marked down, while re-profiling involves de-facto nominal haircuts, given the lack of compensation for extra duration risk.
Dallara is well versed in the game of playing bluff. He touted the risk of a Lehman-like collapse in global markets if investors were forced to swallow an involuntary restructuring in 2011, while, at the time, German chancellor Angela Merkel played hardball, suggesting Germany could stomach a Greek credit event amid eurozone-bailout fatigue. However, he says officials are playing with fire.
“We should not fool ourselves that the eurozone is much better protected today compared with three years ago,” says Dallara. “Although there are crisis support mechanisms in place, resolution funds are still on a country-by-country basis, in Spain and Italy, unemployment is higher now, and three years ago there was an expectation of eurozone growth. Now deflation and weak growth are big concerns.
“The rhetoric of European and Greek officials should be toned down – it is creating material risks.”
He says Grexit risks also threaten to impair the ECB’s monetary transmission, adding: “The ECB is in the middle of launching a massive quantitative-easing programme and market confidence is being undermined just when it wants to see a pick-up in investment and lending."
Holger Schmieding, chief economist at Germany’s Berenberg Bank, sums up the hawkish views of northern European creditors: “Greece already relaxed its fiscal stance slightly in 2014 by 0.8% of its GDP and was on course for a cautious further fiscal stimulus in 2015 and 2016.”
He adds: “Last year, the reforms finally started to pay off, with the long and deep Greek recession giving way to a rebound at an average annualized pace of real GDP growth of 2.5% in the first three quarters of 2014.
“What the left-right populists of the new Greek administration are proposing is not to end austerity in the sense of placing no extra burdens on the Greek people. Instead, they are proposing to grant Greece a major fiscal stimulus by undoing many of the cuts of the years 2011-2013. Even worse, they want to reverse many of the supply-side reforms.”