By Dimitris Kontogiannis
Greece may have avoided a disorderly default by securing the second financing package from the European Union and the International Monetary Fund after attaining the debt reduction goal set out in the private sector involvement plan (PSI), but it is not still out of the woods. A financial accident could occur at any time, with bank deposits likely to overtake public finances as the most vulnerable area.
The PSI will be officially completed in the next few days as Greece makes some tough decisions about the treatment of the holdouts in the foreign law bond category. These bonds amount to 16.9 billion euros in total.
Since these bonds incorporate collective action clauses (CACs), a decision to impose a notional haircut of 53.5 percent even though the assembly of bondholders may have voted against participating in the PSI in some cases will be another indication as to how seriously the Greek government takes the possibility of a financial accident down the road. In this case, this has more to do with the inability of the state to service its debt because the old window of T-bill issuance will be closed than anything else.
However, it is reasonable to assume the fiscal side of the Greek problem poses a smaller threat now than it did in late 2011 since official funding is available and the government seems to be committed to abiding by the new financing agreement reached with the official creditors.
Of course the political uncertainty ahead of the next general elections does not help Greek public finances, as history shows. This, combined with the protracted recession, could lead to the country missing its budget deficit target, creating a financing gap in the next few months, but it should not be sizable given the encouraging trend in the first two months of the year.
If the fiscal side is less likely to be the source of a negative surprise in coming months after the PSI is completed and European Financial Stability Facility (EFSF)/IMF funds continue to flow in as Greece sticks by the latest agreement with the troika, the focus should shift to bank deposits.
Bank deposits of households and firms declined further to 164.4 billion euros in February from about 169 billion in January and 174.2 billion in December 2011. Of course, one has to take into account that February was characterized by a negative news flow regarding the economy and the country as doubts about the success of the PSI persisted for most of the month.
On the other hand, there are increasing signs March was quite the opposite -- that is, a good month -- with bankers estimating deposits inflows of between 1 and 4 billion euros. They attribute this to the success of the PSI, which helped restore some confidence in the banking system since it significantly reduced the risk of Greece exiting the euro in the eyes of the general public.
Readers are reminded that deposit withdrawals have risen to more than 73 billion euros since December 2009 and about 56 billion euros since May 2010, when the country signed the first economic adjustment program with the EU/IMF. Pundits think the Greek public holds between 8 and 15 billion euros in bank safe deposit boxes, houses, gardens and other such places because people are afraid of a return to the drachma.
In addition, tens of thousands of individuals and companies have taken their money out of the country, with the estimated total put at tens of billions of euros. However, the bulk of deposit withdrawals since late 2010 relate to meeting consumption needs, paying taxes and providing working capital, as bank loans have become more expensive and scarce.
Although March may turn out to be a very good month for Greek bank deposits, there is no guarantee the trend will continue in the next few months. Political uncertainty, concerns about the next review of the Greek economy by representatives of the country’s lenders and the contraction of the economy do not point in that direction.
However, the problem of shrinking deposits will be quite dangerous if it persists for a much longer period as the history of indebted countries teaches. The latter have often frozen deposits and/or instituted capital controls to halt the outflows.
Greek banks have relied on cheap liquidity to the tune of 110-120 billion euros from the Eurosystem of central banks and emergency liquidity assistance (ELA) from the Bank of Greece in return for posting collateral in the form of low-quality state bonds or bonds guaranteed by the state to close their funding gap. It is likely the ECB and some national central banks will not be happy to see the Greek banking system becoming more dependent on them. Germany’s Bundesbank became the first central bank to publicly announce restrictions on accepting Greek, Irish and Portuguese collateral.
If liquidity from the Eurosystem of central banks cannot be increased and deposit withdrawals are not halted, the risk of a financial accident is bound to rise. This has to stop and the only way to do so in addition to recapitalizing Greek banks and showing progress on the fiscal front is for banks to consider raising their deposit interest rates.
According to last January’s breakdown of deposits, about 51 percent were in the form of time deposits, around 31 percent in savings and some 10 percent in sight deposits. Time deposits pay the highest interest rates whereas savings and sight accounts pay much less.
Such an increase in deposit rates may considerably slow the deposits hemorrhage but will compress consumption spending and force banks to raise lending rates, depriving the state budget of much-needed revenues. On the other hand, it will help narrow the current account deficit.
Undoubtedly, raising deposit rates is not an optimum solution. However, this may be the only policy tool left to avoid a nasty surprise if liquidity from the European Central Bank and the Bank of Greece to the local credit institutions cannot be increased further and large-scale deposit withdrawals continue.