Greece races against the clock for debt solution

Ten days after a general election in Greece led to the government of Alexis Tsipras assuming on Wednesday, the European Central Bank announced it would lift the waiver that allows the bank to accept Greek government bonds as collateral for funding.

The tersely worded statement, issued just hours after Greek finance minister Yanis Varoufakis met with ECB president Mario Draghi in Frankfurt, represented a dramatic escalatpower in Athens, Frankfurt dramatically upped the ante in the current Greek standoff.

Just after 9.30pmion of the power struggle between Athens and its international lenders.

The events of the past 10 days have been a story of political brinkmanship and diplomatic manoeuvering. On Saturday, the new regime in Athens began its tour of European capitals in a bid to drum up political support for its plan for debt relief.

They began in Paris, where a relaxed-looking Varoufakis met with finance minister Michel Sapin. Visits to London, Rome and Brussels ensued; the mood music seemed good.

As Greece appeared to temper its stance on nominal debt writedown and instead advocate some form of debt swap, which would see Athens replacing existing debt with bonds linked to GDP growth, Mr Tsipras appeared to gain some traction with other political leaders. There was talk of solidarity and compromise, accompanied by smiling pictures of members of the new Greek government with various political leaders.

The honeymoon period abruptly ended on Wednesday. That the ECB’s statement came just hours after Varoufakis had described his meeting with Draghi as “very fruitful” tells its own story. In this Greek drama, the ECB has always been the main protagonist, quietly watching in the background, and ready to act when needed.

The European Central Bank is not known for making quick decisions. Its pledge to undertake OMT (Outright Monetary Transactions), where the bank purchases the bonds of euro zone members in the secondary market, has never been enacted, while its quantitative easing programme was launched, belatedly, only last month.

So the ECB’s decision to ban the use of Greek bonds for collateral was as bold as it was decisive. It also follows reports that the ECB was blocking Athens’ plan to source bridge financing through the issuance of T-bills.

Banks dependent

The decision to lift the waiver on the use of junk bonds as collateral, which will come into effect next Wednesday, will prohibit the use of Greek government bonds as collateral to the ECB’s regular liquidity operations, leaving the Greek banking system dependent on emergency liquidity assistance

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How serious is the new development?

As UCD professor Karl Whelan has pointed out, only around €8 billion of Greek government debt was used in December as collateral for loans from the euro system, out of a total of €56 billion.

What is potentially more significant is the ECB’s stance on emergency liquidity assistance. Although the provision falls to the Greek central bank, a two-third majority in the ECB governing council could ultimately block the provision. Yesterday it appeared that the ECB had approved ELA of up to €60 billion to Greek banks, at least for the moment

Some of the major Greek banks are already tapping emergency funding from the Greek central bank following an outflow of deposits, while the financial system in Greece is also suffering from worsening conditions on the Repo market.

Silvia Merler of the Breugel institute in Brussels says that increasing emergency liquidity assistance to Greek banks will be “very controversial and possibly difficult” for the ECB.

Ciaran Callaghan of Merrion Capital believes the lifting of the waiver will have “serious ramifications for the Greek banking system”, raising the spectre of capital controls as deposit outflows intensify.

Expensive option

Giuseppe Maraffino and Antonio Garcia Pascua of Barclays also point out that

emergency liquidity assistance is more expensive in terms of cost and in terms of haircuts compared with the ECB’s regular refinancing operations.

Greek bank stocks and bond yields took a hammering as markets responded to the ECB move. The Greek finance ministry adopted a sanguine approach, interpreting the decision as the ECB’s way of pressurising the eurogroup “to move quickly to seal a new mutually beneficial deal between Greece and its partners”.

The next meeting of the eurogroup of euro zone finance ministers, on February 16th in Brussels, will be a crucial gathering, though an emergency eurogroup is possible next Wednesday. That's the day before Thursday's summit of EU leaders, at which Tsipras will come face to face with German chancellor Angela Merkel and other EU leaders in his first summit as prime minister.

While market focus is likely to remain on the Greek banking system in the coming days, the political fallout from the ECB decision – and its implications for the future of the Troika – is dominating discussion in Brussels. With the Greek bailout due to expire on February 28th , politically the Greek government has approximately three weeks to secure a compromise. It has said it wants to scrap the current bailout and negotiate a different agreement that would last until the end of May. Varoufakis dismissed the troika in an interview with Die Zeit this week as "a group of technocrats who monitor the implementation of the reform programme".

“They have ruined our country. The troika doesn’t have a mandate to negotiate another policy with us.”.

Legality of troika

Varoufakis’s’s views will elicit some sympathy. The European Court of Justice and the European Parliament have raised questions about the legality of the troika, and particularly the ECB’s role within it.

On election to the head of the EU’s executive arm last July, European Commission president Jean-Claude Juncker said that in the future, the troika should be replaced with a more democratically legitimate and accountable structure.

The ECB’s explained its decision to lift the waiver on Greek government bond because “it is currently not possible to assume a successful conclusion of the programme review”. This suggests that the bank continues to see its role as working within the framework of the agreed bailout programme and as a troika member.

The escalating dispute over the role of the troika and the extension or not of the bailout also reflects badly on former Greek prime minister Antonis Samaras for agreeing only to a two-month extension of the EU part of the bailout in December, rather than the six months favoured by the eurogroup. Continuing the bailout until June might have bought both sides more time to negotiate a compromise, although it is uncertain whether the Syriza-led government would have been prepared to govern under the bailout regime.

Time is not on Greece’s side as it continues to negotiate a compromise agreement with euro zone partners. The IMF is due €2.5 billion in repayments by March, and around €6.5 billion is due to the ECB in the summer.

The fact that about 80 per cent of outstanding Greek debt is held by other European countries means that this is no longer a conflict between bondholders and tax payers, but one between European partners.

The next few weeks will see how far EU member states are prepared to go in the name of European solidarity.