11 February 2015

It’s been a noisy couple of days in the European press. Greek leaders have been trading barbs with their European (mostly German) counterparts and posturing to try and gain an upper hand in negotiations. Today they will finally all come face to face at the Eurogroup meeting.

What does Greece want from a ‘bridge programme’?

Kathimerini had a detailed rundown of the plan which the new Greek government is likely to present to the Eurogroup. The key points are:

  • Scrap 30% of the bailout programme in exchange for 10 new reforms agreed with the OECD (meaning 70% would be kept).
  • Reduce Greece’s primary surplus target from 3% of GDP to 1.5% this year, and keep it around this level for the medium term (as opposed to increasing it to 4.5% as currently planned).
  • A swap plan for the loans to Greece. This is likely to focus around the previous proposals of turning Eurozone loans to Greece into GDP linked loans or bonds and asking the ECB to swap its current holdings of Greek bonds for ‘perpetual bonds’.
  • Allow (if not support) Greece to tackle its humanitarian crisis.
  • Funding will come from €1.9bn in profits on Greek bonds held by the Eurosystem being transferred to Greece and an increase in the limit of T-bills (short term debt) issued by the Greek government of €8bn.
  • Other potential funding lines include tapping into the €7.2bn tranche of EU/IMF/ECB Troika funding waiting to be released or using the €11bn leftover in the bank recapitalisation fund.
  • The plan would run until September and allow time for negotiations over a “new deal” on Greece’s debt.

Could the Eurogroup agree to this and how useful would it be?

The initial signs aren’t good and there looks to be a large divide between the two sides to bridge.

  • OECD reform package: The promise to adhere to 70% of reform programme and agree to 10 new reforms with the OECD would be welcome, but is unlikely to be seen as sufficient to replace the current EU/IMF/ECB Troika oversight – not least because the OECD has no enforcement powers and is a relatively small body. Of course, it also isn’t clear what ‘70%’ of the reforms account for – it could well leave out some crucial pension and labour market reforms, which would not be acceptable Greece’s creditors. Negotiability: Medium
  • Primary surplus reduction: As we have noted before, the primary surplus targets for Greece are entirely unrealistic and as such could provide a basis for some negotiation. A reduction is therefore possible but poses some tricky questions in terms of debt sustainability and market financing. If the surplus is reduced then it is likely that Greek debt will also go down more slowly, while the new funding gap will have to be filled by expensive market based financing. All this would make it hard for the IMF and ECB to maintain the veneer that Greek debt is sustainable – a prerequisite for them continuing to be involved in aiding the country. In the end, as has been done before, this could be fudged with promises of future adjustments. Negotiability: High
  • Short term debt issuance: An increase in the level of T-bills will also be difficult to secure – a similar request was already denied by the ECB last week. Even if the Troika give approval for the ceiling to be raised allowing for the issuance to increase, the ECB itself also needs to sanction an increase in the level of T-bills allowed to be used for borrowing under the Emergency Liquidity Assistance (ELA). If this is not done, then Greek banks (the only real buyers of this debt) are unlikely to have enough liquidity to purchase the new issuance. This could also therefore involve raising the overall ceiling of ELA. Negotiability: Low
  • Eurosystem profits: The release of the €1.9bn in profits from Eurosystem holdings of Greek government bonds looks likely as it has already been agreed, but is again reliant on securing some kind of agreement on a reform programme. Negotiability: High
  • Bond swap: We have noted before that a bond swap is very unlikely to take place (would be a fundamental change in nature of Eurozone and would need approval from national parliaments – essentially a move to fiscal union). But it also does not help Greece as much as many would think. As the chart below shows the very large majority of payments are to the ECB and IMF in the next decade, not the Eurozone. So while swapping out Eurozone loans may make the headline debt figure a bit better, it would do little to ease the payments and liquidity pressure on the Greek government in the next few years.

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  • The IMF is unlikely to budge given its long history of being the most senior creditor around. It would be a huge break with its rules and traditions and would anger many of its members. The ECB has a very strong hand to play given that it can cut of funding for Greek banks at any point if it questions the solvency of the system or the willingness of the state to pay. Some have suggested that the promissory notes deal struck with the wind down of Irish Bank Resolution Corporation (IBRC, formerly Anglo Irish bank) in February 2013 could be a template for an agreement. As we said back then, there are no doubt elements of monetary financing in that deal. However, we think a repeat is unlikely for a couple of reasons. Firstly, the large majority of bonds are held by the ECB not the national central bank (as in the Irish case since it related to ELA collateral). This makes it a direct responsibility of the ECB not just an issue it oversees (a small technical difference but important nonetheless). Second, given the bonds are just a small share of those purchased under the SMP, the precedent set would be more important and could force other bonds to be swapped out. Negotiability: Very low
  • Access to existing funding programme: Of all the points though the strangest request is for access to the €7.2bn tranche due to be paid out or the €11bn left in the bank bailout funds. Not only would this require a continuation of the current programme, completion of the final review and a new programme to be agreed (with similar conditions) but it also goes fundamentally against the comments by the Greek government that the current programmes are ‘over’. Negotiability: Low

Any agreement must apply equally to both sides

Clearly, reaching an agreement will be incredibly tricky and the next week will be incredibly tough. But there is still scope for one to be reached. We would firstly suggest that Greece practices what it preaches. If it wants moratorium, a halt in play to negotiate, then it should also apply to Greece – this means no unilateral policy changes until the negotiations are concluded. No reversal of the minimum wage, labour market or other reforms.

If this can be done, then we would support an agreement to allow for a temporary increase in T-bill issuance and a reduction in this year’s primary surplus target.

A bridge to nowhere?

Fundamentally though, there also has to be an idea of where the ‘bridge’ will go for Greece. As the analysis above suggests, it will be very difficult for Greece to find any serious debt relief. What Greece really needs over the next few years is an easier payment schedule to give it more time to reform and a bit more fiscal flexibility. But this depends on the ECB and IMF, not the Eurozone – as such it will be even tougher to find any room for manoeuvre.

Little progress is expected in today’s meeting of finance ministers and the big risk is that all the time is spent negotiating the bridge agreement with too little thought given to where said bridge will go.

For these reasons we believe Grexit is now more likely than in the fraught period of 2012. Back then we put the chances of Grexit at 25%. We now put them around 40%. A compromise is possible but it will require one side or the other to shift significantly. This still looks more likely to be Greece and Syriza but with strong backing from the Greek parliament and polls showing strong public support for their tough stance both sides positions are becoming increasingly entrenched.