Greece: Thank You Sir, Can I Another?

Observers have taken an almost prurient fascination with some sketchy details of the contingency plans then Finance Minister Varoufakis had developed for Greece if it had been forced to leave the monetary union.   They are hardly surprising in substance. 

Observers have taken an almost prurient fascination with some sketchy details of the contingency plans then Finance Minister Varoufakis had developed for Greece if it had been forced to leave the monetary union. They are hardly surprising in substance.

It was quite clear that gaining control of the central bank’s reserves was an essential step. We had warned that replacing the central bank governor with an ally of the Syriza government was a logical step on the escalation ladder. A separate or parallel payment system would have also been necessary. The precise details are shaped by the particular institutional and technological idiosyncrasies of Greece.

There are three more important issues from which the focus on “Plan B” distracts us. First is the realignment among the creditors. In particular, the IMF’s insistence on debt relief brings it to loggerheads with Germany and several other eurozone members.

The expiration of the second aid program at the end of June also signaled the end of the IMF program that would have run through March 2016. The IMF formally canceled its roughly 28 bln euro program, having only disbursed about 12 bln euros. At the end of last week, Greece requested another IMF package, which it had to do as part of its application for a new three-year loan facility from the ESM.

If the European creditors insist on the IMF’s involvement from day one of the new package, it will bring forward the debt relief discussion. This is obviously what Greece would like. However, several European countries are unwilling to discuss debt relief until it can be verified that Greece is implementing the reforms it promised. The IMF could wait until after the first review, which could take place in the Oct-Nov period unless there are snap elections that could disrupt the time-frame.

The second and arguably the most important point now that the negotiations have begun is whether Greece will be asked to pass additional reform and austerity measures. Recall Greece passed two important omnibus bills that essentially committed the Tsipras government to implementing the prior governments’ commitments and more. These were seen as prerequisites to beginning negotiations for a third package and the 7 bln euro bridge loan.

Greek negotiators argue that these measures should be sufficient to free up the first tranche of aid. Recall aid has been cut off since last summer. The previous government, led by New Democracy’s Samaras failed to implement the accord. Syriza’s election was not the cause of the assistance freeze but may have been the effect.

The passage of the various measures after the nerve -fraying referendum in which the Greek people voted to reject the creditors’ demands has weakened the Syriza coalition. The left-wing of the government has been purged, and Tsipras has had to rely on opposition votes to pass the measures. In some ways then he has become a minority government. Alternatively, with the opposition in disarray (new head of PASOK and leadership contest in the New Democracy Party); Tsipras leads a unity government of sorts.

As the most popular politician in Greece, Tsipras, who is tasked with implementing a program he does not believe in, could be re-elected. The point, however, is that if the creditors demand additional measures as the condition of aid, the political situation could reach a breaking point, which would only slow the reform efforts and weaken the economy further.

The creditors arranged a tight time frame to keep the pressure on Greece. The 7 bln euro bridge loan merely provided to service Greece debt that had come due. It does not cover the 3.2 bln euros owed to the ECB on August 20. Greece also faces interest payments and a small loan repayment to the IMF next month.

The third issue involves Greek banks, markets, and capital controls. Greek banks have re-opened, but capital controls remain in place. At the end of last week, some of the exceptions and rules were tweaked mostly to help facilitate external payments by companies and individuals (including tourists and students). The Greek stock market and other financial markets will likely open before the end of the week. New rules and restrictions will be announced. The ban on short-selling has been extended through August 3. Even when the stock market re-opens, it is possible that trading in Greek banks is not allowed.

The plight of Greek banks is widely recognized, even though they managed to raise about 8 bln euros last year. Deposits have fled. The latest figures suggest that some 8 bln euros or 6% of Greek deposits were removed from the banking system last month. Non-performing loans of Greece’s top four banks stood at 35% at the end of last year, and could only have deteriorated further this year.

Greek banks appeared to have sufficient Tier 1 capital (12.8%), but a good part of this is DTA (deferred tax assets). These are tax credits that can be used to offset future profits, but are hardly funds that can be used. The cost of Greek bank recapitalization hinges to a large extent on the DTAs that will be retreated.

Greece has approved the Bank Recovery and Resolution Directive. It allows for the bailing in of private creditors and depositors (in excess of 100k euros) before government (taxpayers’) funds are used. It is to start at the beginning of 2016. Varoufakis’ replacement at the Greek Finance Ministry, Tsakalotos has indicated bank recapitalization will begin this year. Many recognize that bailing uninsured depositors may be counter-productive.

Much of those uninsured deposits are believed to be the working capital of small and medium size Greek businesses. Penalizing them would likely produce further deterioration of the loan books. Nevertheless, some countries, including Germany, are reportedly pressing for such action as the condition for recapitalizing the banks. There is some debate whether the ESM should take an equity stake too.

There are two other issues that many, including Varoufakis, are still struggling to get their heads around. First, there is a clear link between solvency and sovereignty. The more insolvent a country is, the less sovereignty they have. Greece is insolvent. It has lost much of its sovereignty. When Varoufakis and others complain about the encroachments into Greek sovereignty, it shows they fail to appreciate this critical link. Greece is being asked to do things that other countries have a choice about, like whether shops should be open on Sunday, or when to pass the Bank Recovery and Resolution Directive. It also has to accept EU officials embedded in numerous ministries.

Second, Varoufakis and his many sympathizers fail to appreciate that not all of Greece’s problems can be blamed on Germany, the creditors, or the euro. Similarly, many of Varoufakis’ critics fail to recognize any role whatsoever of external factors. The role of the oligarchy in Greece, or the prevalence of rent-seeking behavior and tax avoidance cannot simply be dismissed as a German plot. Varoufakis and the Syriza fundis talked tough but did nothing to address them even in the most preliminary way.

There are numerous measures that Greece can take to make it easier to cope with the structural rigidities posed by the surplus countries in EMU failing to offset the restrictive course of the deficit countries. Ultimately, creating the conditions for sustained growth arguably will do more to help Greece than all the complaining about EMU’s systemic defects or the creditors’ hypocrisies.