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Just a small post on the newly released June monthly statement by BoG:

BoG monthly statement June 2015

The large increase in central bank lending to Greek banks is quite evident: BoG loans were used to finance increased banknotes hoarding (+€5bn in a month) and deposit outflows (+€7.5bn). This increase stretched posted collateral which reached close to €200bn. Given that debt securities and credit claims held by Greek banks amount at a bit less than €300bn (with around €18bn being securities in currencies other than the Euro) with a significant part encumbered in various covered bonds and other securities it is obvious that banks were running out of available collateral and capital controls were really around the corner as long as ELA financing needs did not decrease. Obviously the increase in haircuts at the 6th Jule meeting only made matters worse. Based on the above numbers it is clear that it will be extremely difficult to relax capital controls without cash/deposits returning to the Greek banking system.

Another interesting observation is the extremely low figure for the government account which amounted at only €600mn. This reflects the large effort by the Greek government to keep paying official creditors during 2015 and the slow deterioration of state finances due to the ongoing recession. Since ELA was capped before the end of June the above figure suggests that the Greek government was in no position to pay the IMF on 30 June even if it wished to do so (since it could only use funds available at the BoG). Its financial position was extremely stretched and it would have to quickly decide whether to resist creditor demands by issuing IOUs or accepting the terms of a new bailout.

Even if government entities still had funds in bank accounts that could be tapped by the central government, the ELA cap made transferring them to the government account held at BoG close to impossible. These funds might be able to help in domestic payments to government employees and pensioners but would not allow paying (principal and interest on holdings of) foreign debtholders making Grexit very likely in order to avoid a general default on government debt.

One last issue that I don’t see people touching often is the fact that the very large ELA amount will result in significant windfall profits for BoG during 2015 which will be remitted back to the government. Assuming an ELA spread of 150bps over the MRO rate (BoG has to pay the MRO rate on its liabilities towards the Eurosystem), BoG should have already earned an amount close to €450mn in profits (although a part will probably be set aside as provisions). These profits might prove significant for the 2016 state budget execution.

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A few days ago, this article would have started with the statement that Grexit is closer than ever. Today it seems that Grexit has been postponed for a few months. Yet I fail to understand the underlying strategy of the Greek government since the proposed austerity measures (along with capital controls and low confidence) are destined to push the economy in a deep recession. This recession will make achieving the primary surplus targets even harder and government debt clearly unsustainable (even based on the IMF’s quite optimistic projections). The current program will fail in 2016 and Grexit will come back on the table with a Greek government that enjoys a much more fragile domestic political support and an even weaker economy with a higher output gap.

Probably the biggest problem of returning to the drachma is the fact that there are certain (probable) scenarios where the economy almost collapses and others where we observe the usual path of a large devaluation following an unsustainable currency peg: A short-lived large fall in output followed by a long path of economic growth. Usually people will just choose the scenario that fits their story and ideology and not consider (or even imagine) any other possible paths. The ‘ugly scenario’ basically includes official creditors accelerating Greek debt in the form of EFSF loans and the Greek Loan Facility. That will push Greece in a permanent default state and most probably not make it able to accumulate any foreign reserves (since they would be claimed by creditors). EU structural funds will most likely be lost and Europe will not support the newly created currency exchange rate in any way. Greece will have to function in a ‘semi-pariah’ state with strict and permanent capital controls and an economy that will slowly lose most of its human capital and internationally oriented sectors (such as shipping).

In this blog post I will not analyze the above scenario any further but rather take a closer look at a controlled exit from the Eurozone which will include the help of the other Euro member countries (if not for anything else but to enhance the recovery of their official loans).

First of all let me remind people that currency movements happen mostly because of large gross capital flows and not due to the underlying real trade flows (this paper from BIS Claudio Borio is quite informative). Capital flows, at least in the short-term, will happen for only a few reasons:

  • RoW liquidating domestic claims in order to transform them in foreign currency (think of other Euro banks not rolling over repos with Greek banks or equity investors exiting the Greek stock exchange).
  • Domestic firms and households trying to exchange their liquid assets (mostly deposits) for foreign currency.
  • Institutional players taking large currency positions. This requires being able to borrow large amounts of the currency that will be shorted at favorable terms.

In the Greek case we know that a Grexit will happen under strict capital controls (which are already present), while the terms and price (interest rate) under which the RoW will access the drachma will be determined exclusively by Bank of Greece. Since drachma does not exist in any way, a Eurodollar market is not present and cannot help anyone to circumvent capital controls. Private players outside Greece have already liquidated most of their claims (either equity or interbank loans) while the bulk of Greek liabilities are long-term official loans by other Eurozone member countries. The same is true to a large extent for Greeks themselves who have moved large amounts of liquidity outside Greece. This is the main reason why BoG has more than €120bn in liabilities towards the Eurosystem (Target2 and extra banknotes combined).

As a result, coupled with the presence of capital controls and the fact that Greece already has a strong current account surplus (on a yearly basis) there is actually small scope for strong pressure on the exchange rate of a newly introduced drachma. It is probably one of the few times that capital controls can truly be used as a policy tool and not to trap large funds looking for a way out (as was the case in Iceland). As long as outstanding Greek debt to the ECB (in the form of SMP bonds) and the IMF is rescheduled in the form of a long-term loan by the ESM, the GLF spread over Euribor is lowered to  5bps and interest payments postponed until 2020 (as has already happened with the EFSF loan) Greece will have truly minimal refinancing needs (in terms of foreign currency obligations) for the rest of the decade and be able to slowly accumulate FX reserves through its current account surpluses.

The main subject where a host of different opinions exist is what will happen with ELA financing by BoG and the corresponding liabilities towards the Eurosystem. The story usually goes that BoG will have to default on these liabilities and the Eurosystem having to perform a large capital injection. In my view any such claim is most probably false, at least in the favorable scenario. EU already has an exchange rate mechanism for EU members that do not participate in the Euro area but wish to maintain a controlled exchange rate relationship, called ERM II. This mechanism defines a ‘central exchange rate’ with the Euro, with a fluctuation band of +/- 15%. Intervention at the margins is automatic and unlimited while a short-term financing facility exists with a maturity of 3 months (which can be renewed at least once):

for the currency of each participating non-euro area Member State (hereinafter ‘participating non-euro area currency’) a central rate against the euro is defined;

there is one standard fluctuation band of ± 15 % around the central rates;

intervention at the margins is in principle automatic and unlimited, with very short-term financing available.

For the purpose of intervention in euro and in the participating non-euro area currencies, the ECB and each participating non-euro area NCB shall open for each other very short-term credit facilities. The initial maturity for a very short-term financing operation shall be three months.

The financing operations under these facilities shall take the form of spot sales and purchases of participating currencies giving rise to corresponding claims and liabilities, denominated in the creditor’s currency, between the ECB and the participating non-euro area NCBs. The value date of the financing operations shall be identical to the value date of the intervention in the market. The ECB shall keep a record of all transactions conducted in the context of these facilities.

The very short-term financing facility is in principle automatically available and unlimited in amount for the purpose of financing intervention in participating currencies at the margins.

For the purpose of intramarginal intervention, the very short-term financing facility may, with the agreement of the central bank issuing the intervention currency, be made available subject to the following conditions: (a) the cumulative amount of such financing made available to the debtor central bank shall not exceed the latter’s ceiling as laid down in Annex II; (b) the debtor central bank shall make appropriate use of its foreign reserve holdings prior to drawing on the facility.

Outstanding very short-term financing balances shall be remunerated at the representative domestic three-month money market rate of the creditor’s currency prevailing on the trade date of the initial financing operation or, in the event of a renewal pursuant to Articles 10 and 11 of this Agreement, the three-month money market rate of the creditor’s currency prevailing two business days before the date on which the initial financing operation to be renewed falls due.

My view is that in the case of a Grexit current BoG liabilities towards the Eurosystem will be transformed into a long-term financing facility, capped somewhere close to their current level. BoG will have to pay interest to the Eurosystem, either the 3-month rate applicable to ERM II financing facility or the MRO (as it happens today for Target2 liabilities) with the clear agreement that BoG will use its FX reserves in order to slowly pay back the facility (through annual current account surpluses). This will obviously mean that BoG financing towards Greek banks will remain significant, absent a domestic QE program. Short-term financing by the Eurosystem will be provided in order to facilitate temporary FX needs (the Greek current account is actually in deficit during the first months of a year) and to allow the smooth payment of government liabilities denominated in Euros. Obviously this financing facility will be capped for intramarginal interventions.

As long as the central rate is reasonable and both sides are determined to defend it through monetary policy (interest rates), capital controls and automatic interventions, confidence on the drachma will quickly be strengthened and domestic players will have little reason to try to convert their assets into foreign currency.

Obviously one important problem is the fact that creating the actual physical currency will take time. Electronic payments as well as the over €50bn in Euro banknotes circulating in Greece right now (for a GDP of less than €179bn) will help minimize the short-term impact.

Although I hope the above will remain only a scenario exercise, it is my view that, given the political climate inside Europe and the short-term economic reality, Grexit will emerge again during 2016, especially if the current package is not accompanied by serious debt restructuring.

Given the recent substantial increase in Greek political risk and the high probability of early elections I ‘d like to comment on a recurring theory that ECB can threaten to close down Greek banks access to liquidity (in the same manner it did in Cyprus) in case that a newly elected Syriza government does not adhere to the currently agreed upon measures, reforms and budget cuts.

In my view, 2015 is quite different than 2012 and the possible threats that the ECB could (then) make against Greece are no longer possible.

The main measure that the ECB can take against Greece in case that the current program is put on hold is to remove the waiver on accepting Greek government guaranteed securities and other assets as collateral in its regular refinancing operations. The important fact to keep in mind though is that Greek banks do not hold significant amounts of Greek government bonds on their balance sheets any more. They only have a little over €10bn of relevant securities of which almost €5bn are Treasury Bills. The collateral being used in ECB operations are mainly the EFSF notes that banks acquired from the Hellenic Financial Stability Fund (HFSF) when they were recapitalized after the PSI. The nominal value of these notes exceeds €37bn which coupled with other assets (such as credit claims) covers current ECB financing which stands close to €45bn.

Any additional financing requirements can be covered through ELA financing although this will necessarily result into much higher borrowing costs (since the ELA rate is more than 150bps higher than the ECB marginal lending rate). The threat of closing down ELA (as in Cyprus during 2013) is only possible if the Greek banks do not cover minimum capital requirements. Given that it’s only been a few weeks since the ECB stress test results were announced during which the central bank affirmed the strong capital position of Greek banking institutions it is not at all clear how the ECB would be able to justify not allowing or placing hard limits on ELA financing.

Moreover, even if negotiations between Greece and its creditors go south this cannot have any effect on the EFSF notes held by banks since any principal and interest payments on EFSF loans will be made after 2020 (interest payments have been deferred and capitalized until at least 2022). Coupon payments on PSI bonds (including bonds issued during 2014) stand around €1bn per year and do not create substantial problems. Unfortunately the EFSF loan does contain cross default clauses referring to the rest of Greek obligations so a future Greek government should proceed with caution although the Greek law covering ECB SMP bonds does provide some room to maneuver* .

Greek debt payments during 2015 mainly involve T-Bill rollovers and payments of €7bn towards the ECB (for SMP bonds) and €9bn towards the IMF:

Greek Bonds T-Bills 2015

ECB’s main leverage over Greece concerns whether liquidity will be provided through regular OMOs or ELA and if Greek bonds will be included in a possible future QE program. The latter will obviously allow a much more orderly access to capital markets for bond issuance, especially coupled with the presence of an EFSF ECCL program.

* When I first wrote the post I had in mind that ECB Greek bonds are covered by Greek law. It turns that the ‘default events’ on the EFSF financing agreement cover more or less all of Greek government liabilities.

Η ΤτΕ ανακοίνωσε τα στοιχεία του ισολογισμού για τον Μάρτιο. Μετά την ολοκλήρωση του PSI οι Ελληνικές τράπεζες επέστρεψαν στη χρήση των πράξεων ρευστότητας του Ευρωσυστήματος (το Φεβρουάριο αυξήθηκε δραματικά η χρήση του ELA), αν και μειώθηκε το ποσό των πράξεων μακροπρόθεσμης ρευστότητας στα 36,8 δις € από 47,6 δις € το Φεβρουάριο. Θετικό είναι ότι τόσο οι υποχρεώσεις λόγω χαρτονομισμάτων, όσο και οι υποχρεώσεις προς το Target2 μειώθηκαν σημαντικά το Μάρτιο (17,7 δις € από 19,4 δις € και 103,7 δις € από 107,3 δις € αντίστοιχα), βελτιώνοντας τη συνολική θέση του τραπεζικού συστήματος κατά περίπου 5 δις €. Αντίστοιχη βελτίωση φαίνεται και στους λογαριασμούς τάξεως, όπου το ενεργητικό το οποίο χρησιμοποιείται ώς εγγύηση για παροχή ρευστότητας μειώθηκε από τα 288 δις € στα 261,9 δις €. Ο ELA βέβαια επανήλθε σε λογικά επίπεδα σε σχέση με την εκτόξευση των ‘Λοιπών Στοιχείων’ στα 109,4 δις € το Φεβρουάριο.

Από την άλλη, οι λογαριασμοί τάξεως κάνουν σαφή τα αποτελέσματα του PSI πάνω στο χαρτοφυλάκιο ΟΕΔ των ασφαλιστικών ταμείων και λοιπών οργανισμών. Έτσι, οι εγγραφές (1) και (2), μειώθηκαν από 32,1 δις € το Φεβρουάριο σε 19,55 δις € το Μάρτιο, απώλεια 12,55 δις €. Σε συνδυασμό με τις συνολικές διαγραφές των Ελληνικών πιστωτικών ιδρυμάτων περίπου 25 δις € σε κρατικούς τίτλους, ο λογαριασμός του PSI για την Ελληνική οικονομία ξεπερνάει τα 37 δις €, χωρίς μάλιστα να λαμβάνονται υπόψη οι ζημιές των φυσικών προσώπων και οι ζημιές στα δάνεια προς την κεντρική κυβέρνηση (οι οποίες πιθανότατα έφτασαν τα 2,5 δις €),  καθιστώντας το σε μεγάλο βαθμό εθνική υπόθεση ή καλύτερα ‘εθνική διαγραφή ενεργητικού’.

Φαίνεται όμως ότι η Ελλάδα κατάφερε με την εφαρμογή του PSI να φέρει πιθανότατα το ΔΝΤ και στην Κύπρο λόγω της διαγραφής 3,5 δις € από το ενεργητικό των Κυπριακών τραπεζών, μέγεθος ίσο με το 20% του Κυπριακού ΑΕΠ, παρότι οι Κυπριακές τράπεζες είχαν καταφέρει να μειώσουν την έκθεση τους σε κρατικούς τίτλους από 16 δις € το 2011 σε 8,5 δις € πριν το PSI.