Agreement more likely than previously

Monday’s emergency eurozone summit could mark a significant, but not the final, attempt to strike a deal to avert a financial crisis in Greece before the deadline at the end of June. The hardening of the government’s and the lenders’ positions is not a good omen but a deal is still possible, as Chancellor Angela Merkel said. The reaction of the markets and especially the actions of the European Central Bank could play an important role in the outcome of the negotiations.

On February 4, the ECB decided to remove the waiver that allowed the securities issued or guaranteed by the Greek government to be eligible collateral for its refinancing operations despite their speculative grade rating by international credit rating agencies. The reason was that the governing council of the ECB thought the prospects for a quick conclusion of the fifth review of the Greek program were not good.

It was an important move because it forced local banks to get funding from the more expensive emergency liquidity assistance (ELA) mechanism of the Bank of Greece. It also left them with a stigma since banks access ELA loans when there is distress. Of course banks continued to be funded via the ECB refinancing facilities by providing high-quality collateral, that is, EFSF (European Financial Stability Facility) bonds. It is estimated they got about 38 billion euros from the ECB directly. However, the rest of the money, which is a bigger amount, exceeding 80 billion euros, is coming from ELA.

Asked about Greece, the president of the ECB, Mario Draghi, recently said the European Central Bank is a rule-based institution and will act accordingly. Since the country is in a program, the ECB takes it into account when looking at the local banks. It is known that last February’s decision was linked to the standing of the adjustment program. In other words, the decision was taken because it was deemed at the time that the program was getting off track. So, the course of the negotiations and most importantly the outcome of tonight’s summit will likely influence the decision of the ECB.

Tough statements made by high-level EU officials over the last few days have heightened tensions, along with defiant statements by Greek government officials, making many people wonder what is next. It is generally agreed that the lack of progress will make the prospect of an agreement before June 30 very unlikely. In contrast, a deal or significant progress will calm things down, reduce uncertainty and convince the ECB to keep providing liquidity to Greek banks until the end of the month at least.

There is no doubt the acceleration in deposit outflows and the provision of extra ELA to Greek banks by the ECB on Friday have increased concerns. It also explains why talk of capital controls has returned although the authorities dismiss it. Analysts predict the ECB will continue to provide the necessary liquidity to the Greek banking system as long as the prospect of a deal is likely. The ECB reportedly raised the limit on ELA liquidity by an additional 1.8 billion euros on Friday, following a 1.1-billion-euro increase midweek. Assuming the latest figure is correct, since there is no official information, the ELA limit stands at 85.9 billion euros. It could increase further on Monday, if the ECB acts again, depending on the behavior of Greek depositors.

Draghi has said the ECB will continue to authorize ELA funding as long as the Greek banks are solvent and they have available, eligible collateral. It is estimated that the available collateral amounts to 30-33 billion euros but a haircut by the ECB could shave or even eliminate it so banks would not be able to get more loans via ELA, leading to limits on cash withdrawals and international transfers if deposit outflows continue. It should be noted the government has ruled out legislating the imposition of capital controls.

So, it is important that progress is made tonight, so the ECB stays on board and does not have to apply its risk-based approach to the eligibility of Greek collateral. If there is no progress at the emergency summit, the ECB may decide to apply a haircut. This may be manageable for Greek banks at first but difficult to handle as time passes and deposits continue to flee, or the ECB proceeds with an even bigger one later as risks go up.

This is clear to all sides and especially the government, which has been under more pressure lately as the deposit outflows accelerated. Bear in mind that last time Greece faced the prospect of capital controls, back in February, there was a Eurogroup agreement. A number of pundits think this could be repeated again this time, and therefore expect a compromise. This is in accordance with high-level government sources saying in private for some time that they expected a last-minute deal.

If one combines the possibility of capital controls, which everybody wishes away, with their belief in a last-minute agreement deal, one should conclude an agreement is more likely now than before. Of course government officials have claimed a deal was about to be struck before and it never happened, so one should be justifiably cautious. However, this time may be different since time is up.