12 June 2015

How would Greek capital controls be implemented and what form might they take?

It’s likely that such controls would need to be brought in over the course of a weekend, though I expect they may also need to be combined with some bank holidays anyway.

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  • Cash/ATM withdrawal limits: This would be a vital control in order to halt the huge outflow of deposits which has been taking place and which will pick up if a deal isn’t struck soon. In Cyprus the limit was set at €300 per person per day. However, I suspect ones in Greece may go even lower. This is because Greece is suffering from serious domestic withdrawals while the primary concern in Cyprus was foreign outflows.
  • Foreign transfer controls: The aim here would be to limit the amount that people can transfer abroad from Greece in one go and also over a set period. Obviously some transfers are needed for businesses to function so there would need to be a process by which businesses related (and other verified) transactions could still go through.
  • Time requirements or taxes: Other options or versions of the above include taxing certain withdrawals or foreign transactions heavily. This has the advantage of potentially creating a revenue stream for the government, though it may come at a very high cost. The government could also decree time limits on certain deposits or investments in an attempt to limit withdrawals indirectly.
  • Physical controls: Obviously with free movement within the EU it would be quite easy for people to move large amounts of cash or assets across borders. As such there will need to be checks and limits on the amount of cash people can take abroad with them. This may also have to extend to assets. For example, someone could purchase a car and then try and drive across a border and sell it on. This is tricky to police but some attempts may well be made.

What impact would Greek capital controls have on the economy?

A significant impact. Greece is still predominantly a cash economy. As such, capital controls have the potential to create a huge liquidity crunch. This was seen in Argentina in the early 2000s when capital controls were imposed.

Generally, the limits on withdrawals as well as transactions will make it very hard for companies to do business. Foreign business in particular will become difficult. The overall impact will depend for how long the controls stay in place for and how stringent they are.  Cyprus was able to remove the capital controls after two years (after periodically loosening them) while Iceland is only now expected to remove its controls, 8 years after they were imposed. For Greece, the controls will only be able to be removed once the risk of Grexit has been tackled. This means probably once a short term and long term deal have been struck with the Eurozone over how Greece will fund itself for the coming months and years.

When might capital controls be imposed?

As discussed before, there are a few scenarios which could trigger the need for capital controls:

  • A default – this would likely be if Greece missed its payment to the IMF at the end of the month. Such an event would probably increase concerns and possibly precipitate a bank run. However, this would also be linked into the following triggers.

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  • An end or cap on central bank liquidity – the ECB is currently reviewing the provision of Emergency Liquidity Assistance to Greek banks on a weekly basis. If no deal is forthcoming it may refuse to raise the limit or it could tighten up the collateral rules, thereby reducing the amount Greek banks can access. If deposit withdrawals continued while the ELA was capped, there would be a funding gap and capital controls could be needed. The ECB could cut off ELA entirely if the bailout expired or if Greece defaulted. However, it must be noted that so far the ECB has been reluctant to be the one that pulls the trigger on worsening the situation.
  • Bailout expires – at the end of the month, when the current bailout expires, if there is no deal there will be a huge amount of uncertainty. This again could trigger bank runs. As such, controls may be needed.

Overall, if there is no deal soon then capital controls will look increasingly likely, especially as we close in at the end of the month when there is a tough IMF payment to make and the bailout expires.

Why would Greece go for capital controls?

This seems an obvious answer given all of the above – to halt bank runs and stop money flowing out of the economy. But there is a wider question that needs to be answered. What would be the aim and end goal of capital controls? Ultimately, capital controls are only really of use when it comes to buying to time or pushing through some tough policies. In Cyprus and Iceland the controls were needed to impose tough write downs on foreign depositors/investors but stop huge outflows of money. But the actual write down was over fairly quickly. But in Greece the problem is a long term malaise and huge uncertainty over its future position in the Eurozone – not a singular one off event for which time needs to be bought.

In the end then, I find it hard to see why the Greek government would want to go for capital controls. They would only be of use if we got to the stage where a deal was close but couldn’t be struck in time. But if we get to that it will be because the differences between Greece and its creditors could not be solved over the past 6 months. It’s not clear that a few extra days, weeks or months under capital controls would drive an agreement. It’s also not clear why the government would want to put the economy and people through the pain of such controls to then just agree a deal. Why not just agree one now? Surely, it doesn’t seem likely that Greece’s negotiating hand would be stronger under such controls?

So, while capital controls are technically possible, I have failed to see any clear answer as to why they would actually desirable, especially from the Greek perspective.

That is why I believe that capital controls would most likely be a prelude to a Grexit. At least here they would serve a clear purpose – allowing time for the transition to a new currency to be organised and negotiated. They would likely need to be even more stringent and probably involve longer term bank holidays. Therefore, when capital controls start to become seriously discussed, it is probably quite a negative sign.