ECB holds key to Greek developments

Greece is preparing to go to the polls next Sunday with the two larger political parties sharpening their exchanges and making more promises in a bid to boost their election chances. Regardless of who wins and forms a government next week, the key to economic developments in the next few weeks, and perhaps months, is held by the European Central Bank (ECB) – and even more so if the new government is led by the leftist SYRIZA party.

Greece has been unable to collect a total of about 7.3 billion euros from bailout loans and revenue from Greek bonds held by the ECB because the last review of the economic policy program was not successfully concluded on time. Nevertheless, the state has managed to operate smoothly for months because it has tapped domestic liquidity sources.

Indeed, the state has been kept afloat by intra-governmental borrowing through repo (repurchase agreements) operations to the tune of 9 billion euros according to government sources. The central administration uses state assets as collateral to draw on this excess liquidity from general government subsectors, i.e. social security funds, state organizations etc, which amounted to about 13 billion euros last September.

If the repayment of this borrowing is rolled over, this repo framework will become an actual funding source in 2015-2016. The central administration could also use idle cash resources deposited in local commercial banks by the same or other parts of the general government for liquidity purposes. The exact amount of these cash resources has not been made public. When asked, one official put it a 2 billion euros, while another spoke of “several billion euros.”

In addition, the state had borrowed temporarily some 2.5 billion euros out of about 11.3 billion left over from the recapitalization of the Greek banking system, according to one of officials.

Nevertheless, the stalemate with the official lenders could go on longer if no new government is formed and the country holds a second round of elections within a month or a new government is formed and enters into lengthy negotiations with the country’s creditors. Although the first outcome is possible, the second is more likely. Especially if a SYRIZA-led government takes over and refuses to negotiate with the troika, seeking instead “political negotiations,” with all issues back on the table.

SYRIZA officials have repeatedly said they reject the program and will not honor it. Whether this is simply a pre-election tactic to win over more voters fed up with years of austerity or the main policy plank remains to be seen. We believe these officials express the party’s line on the issue. In that case, the state will not be able to count on more bailout loans to keep on going and will have to rely more on domestic borrowing or/and higher taxes.

Since the available cash resources will be fully utilized in February, according to experts, and help from the fiscal side, namely the primary surplus, will likely be limited, the new government will have to turn to the banks for extra funding.

SYRIZA officials have hinted at issuing more T-bills to satisfy borrowing needs, if necessary, as long as negotiations with the lenders go on.

Of course, there is an agreement that the outstanding stock of T-bills cannot exceed the amount of 15 billion euros. Nevertheless, the ECB allowed this limit to be surpassed by 3 billion or more in August 2012 to help Greece repay maturing bonds mostly held by the ECB at the time. So, it is possible to see a repetition of that this summer when other Greek bonds held by the Eurosystem expire.

However, the state will likely have greater borrowing needs in the meantime and may want to sell more T-bills to local banks to pay part of its bills. That’s where the ECB comes in. Although it will be impossible for the governing council of the European Central Bank to refuse Greek banks access to loans from the Bank of Greece’s emergency liquidity assistance (ELA), it can impose an upper limit on the amount of T-bills each local bank holds.

Bankers say the ECB could send a letter to each of the local credit institutions to that end and they certainly know more about this issue. It is reminded the ECB has been the regulator of Greece’s four largest banks since last November.

Bankers say that the ECB is entitled to do this if it thinks there is a risk management issue. Still, this is a politically sensitive issue in our view. It is estimated the four major banks hold Greek government debt to the tune of 20 billion euros or so, which is not far from their total share capital.

Something like this could change the landscape since the state could not count on extra T-bill issuance to cover its funding needs.

Undoubtedly, this is more likely if the Greek program is not extended and is more important than buying bonds from Greek banks when the awaited QE (Quantitative Easing) scheme is announced on Thursday. This is why we say the ECB holds the key to future economic and other developments in the country.