There’s a lot of talk lately (again) about a possible Greek exit from the Euro in the near term future. Personally i find such scenarios a bit extreme since i cannot really think of many ways were Greece can actually be pushed to exit the Eurozone.

Regarding outstanding government debt, this can now be broken down in four categories. Loans from the Greek Loan Facility and EFSF, post-PSI government bonds, T-Bills and bonds held by the ECB. Based on Bloomberg data the post-PSI bonds outstanding amount is €62.4bn while T-Bills stood at €15bn in June 2012 (they were increased during August in order to pay ECB maturing debt).

The post-PSI bonds do not pay principal until 2020 and current coupons are only 2%, meaning that annual interest cost is only a bit more than €1.2bn. That is equal to a typical T-Bill auction reflecting the fact that the costs are easily financed by the existing T-Bill issuing mechanism. T-Bills are mostly held and rolled over by the Greek banking system, with a bit of help from Bank of Greece ELA financing. Consequently, all of the Greek tradable debt securities can be assumed to be ‘safe’ in the near-term. Loans and EFSF notes also only pay interest for now. The budget primary deficit has dropped significantly and based on Bank of Greece data till July it was only €2bn.

As a result, the main risks regarding debt refinancing include:

  • ECB held bond redemptions.
  • Interest payments on Greek Loan facility debt.
  • Covering the primary budget deficit.

Even if Greece were to default (in one form or another) to its payments to ECB, it would be legally challenging for the latter to consider this as a general default event and not allow Bank of Greece to accept government paper in ELA financing. Covering the budget primary shortfall can be managed by a couple of large T-Bill auctions while the latest €11.5bn packet is expected to turn the deficit into surplus by next year. My view is that European countries will not risk calling a default on their loans and will continue to service their interest payments through the escrow account. All in all, debt financing seems hard to become a trigger for an exit event.

The main risk in my view is covering euro outflows through ELA financing. Possible triggers are:

  • Reaching a ECB imposed limit on ELA financing with the ECB choosing not to increase BoG limits (and the latter honoring them).
  • Having the banking system run out of available collateral to post to the BoG.

According to the latest BoG balance sheet data, Greek banks have pledged at least €250bn in assets. Based on ECB data ‘total loans to other euro area residents’ in Greek banks balance sheets stand at €240bn while holdings of securities are at €41bn and remaining assets at €43bn (i am not so sure how much of the €64bn external assets can be used). It is clear that the situation is very tight and a small shock can push the system to its limits, especially since most of the remaining assets are valued much lower than par. Still, BoG can do accounting gymnastics and use government guarantees in order to value collateral much more favorably than their fair/market value.

Having the ECB set a hard limit on any of the BoG refinancing operations will basically transform the Eurozone from a monetary union to a fixed exchange rates area. Although it is probably theoretically possible, it is very difficult from a legal point of view (especially since BoG retains the risks of ELA and only provides collateralized loans) since it surely does not promote financial stability (but rather is used as a mechanism to protect the Eurosystem balance sheet) and will obviously introduce a huge risk in the Eurozone. Any holder of euros in a periphery country should try and ‘exit first’, before a possible ‘ceiling’ on outflows is reached, something which is not possible now given the unlimited overdrafts in Target2 liabilities of NCBs.

In summary, i believe that any exit will basically be the result of tight political negotiations and agreement. The ability of the rest of the Euro countries to actually push Greece out of the Euro (especially without risking full contagion in Spain and Italy) is extremely limited in my view.

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