Mere cash injection may not be enough

The Greek government has invested a lot in the long-awaited bailout tranches to cope with the developing credit crunch and bring the economy to the stabilization phase late next year. However, a closer look at the figures indicates the positive impact may be less than hoped for, and therefore the risk of disappointment on the back of fostering high expectations should not be ignored or underestimated.

After much deliberation, the group of eurozone finance ministers decided to disburse 34.3 billion euros in bailout funds to Greece earlier this month and authorize the disbursement of two more tranches in the next few months. Greece is to receive a total of about 49 billion euros by the end of March 2013 and an additional amount of 3.4 billion euros from the IMF, bringing the entire amount to 52.5 billion euros, assuming the country complies with the terms of the new bailout agreement. The sum of 11.3 billion euros in the form of European Financial Stability Facility securities has already been used to pay for the debt buyback.

In addition, new initiatives were agreed to slash the projected debt-to-GDP ratio to 124 percent in 2020 from an estimated 144 percent, including debt relief of 21 billion euros via the recently completed debt buyback and interest rate cuts on bilateral EU loans in exchange for more policy commitments from the Greek side. The new initiatives support the case for a more sustainable public debt in the long haul but the majority of analysts and others strongly doubt they will suffice to convince the markets to start lending to Greece again.

Nevertheless, it is commonly accepted the adjustment program will slide off track again if the economy underperforms and the recession turns out to be much deeper than the officially projected 4.5 percent next year. Government officials have pinned a good deal of hope on the EU and IMF bailout funds to avert such an undesirable outcome. Much centers on the repayment of long- overdue bills to domestic creditors, including pharmaceutical companies, exporters and others, and the recapitalization of the systemically important Greek banks to restore the flow of credit to the economy.

Although no one doubts the positive impact of the bailout money on the economy, many analysts, bankers and others are cautious and less optimistic than officials. According to them, the real flow to the economy will in fact be the 7-8 billion euros earmarked for domestic arrears. Still, a few of them argue the actual flow will be smaller, since they expect some companies and individuals to hoard cash after repaying bank loans and their own overdue bills to the state, suppliers and employees. Unfortunately, this is the feeling one gets when talking to some company executives who admit new investments are not in their business plans for next year, citing the lack of visibility, suppressed consumption and insufficient bank funding.

Government officials and others reckon bank credit to the economy will be gradually restored following the recapitalization of important local banks, facilitating the realization of private investments put on hold. Greek banks are going to receive some 23 billion euros in the form of EFSF bonds out of the total 49 billion from EU funds by the end of January 2013 for the recapitalization and resolution process, with 16 billion euros allocated in the EU bailout tranche of 34.3 billion. This amount is additional to the sum of 25 billion euros in bridge capital already injected earlier this year.

The numbers may look big and promising but the credit inflows could turn out to be much smaller for two reasons. First, there should be strong demand for loans by healthy companies. However, it is not clear whether financially sound firms are willing to borrow much more than for refinancing existing loans. On the contrary, there seems to be a lot of demand by problematic companies and individuals but these are not the type of borrowers recapitalized banks want to lend to.

Second, and perhaps more important, banks will likely continue to face liquidity constraints after the recapitalization process is complete unless deposits grow fast. Government officials and some bankers hope some deposits will return, betting on increased confidence in the banking system by the public, following the large capital injections. But this remains to be seen, bearing in mind the protracted recession.

The major constraint preventing local banks from extending a lot of credit to the economy remains their dependence on Eurosystem funding to the tune of 125-130 billion euros. Their capacity would have been enhanced by a few billion euros if the stock of Greek treasury bills held by banks was reduced. Yet the state has no plan to do so and the stock is expected to remain unchanged at around 18 billion euros according to one official. Moreover, the European Central Bank is unlikely to agree to a rise in the Eurosystem’s exposure to the Greek banking system by increasing the overall limit, while some analysts even expect the ECB to seek a smaller exposure at some point. On the other hand, a number of top bankers expect local credit institutions to gradually regain access to money markets after the recapitalization. If this turns out to be true, it could help reduce the banks’ dependence on Eurosystem funding and/or boost credit to the economy.

All in all, the huge bailout funds should have a positive effect on the Greek economy, partly tackling the credit crunch. However, the impact may be smaller than officials hope for as actual credit flows may disappoint on cash hoarding and banks’ continuing large dependence on Eurosystem liquidity. It will take a sizable return of deposits in the face of a deep recession and banks’ obtaining access to money markets after recapitalization to prove the optimists right. Therefore, the risk of disappointment on the heels of rising expectations should be taken into account.

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