1 April 2015

It seems likely that Greece can make payments covering pensions and wages for public sector workers in March, but beyond today the picture is far less certain. Even if Greece manages the 9 April payment, it has to roll over €1.4bn of short-term debt (T-bills) on 14 April and a further €1bn on 17 April – a much tougher proposition given the recent ECB decision to legally limit the amount of T-bills that Greek banks can hold. This means they won’t be able to increase their share of the debt to cover for foreign owners who are unlikely to roll it over.

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So what happens if Greece does not pay the IMF? How serious would this be?

Are countries often late in paying the IMF?

While it is well known that no country has defaulted on the IMF in its 70-year history, it is less well known that there have been a number of late payments. Furthermore, as the chart below shows, there continue to be a sizeable amount of arrears with the IMF outstanding (the chart is in Special Drawing Rights, 1 SDR = $1.38 currently).

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That said, the large majority of these arrears are made up of countries such as Sudan, Zimbabwe and Somalia – not Greece. Furthermore, the total amounts are far below what would amass if Greece stopped making regular payments to the IMF – its total payments this year to the IMF are €9.7bn.

IMF internal reaction

The first step would be the IMF reaction. As detailed in the IMF’s ‘Strategy on Overdue Financial Obligations’, there would actually be little action until 1 month has passed. Before then, the Fund would continue to push the state for prompt payment. After a month, the IMF’s Managing Director Christine Lagarde notifies the IMF Board that an obligation is overdue.  This is the point where the country is officially considered to be overdue on the payment, in the sense that this is where the knock-on effects would kick in.

Potential knock-on effects

The real problem may not actually be the IMF reaction – given its presence as senior creditor it is confident of getting paid back in full at some point – but the knock on effects of not making good on payments to the IMF.

IMF stops cooperating with Greece – One of the biggest problems for Greece is that it is still working with the Fund and relies on its sign off (as part of the ‘institutions’) to get its current review completed and therefore funding released. The response of the fund on the ground will therefore be important. Of course, the fund finds itself in a bit of a circular position. It is unlikely to get paid if it does not approve Greece’s review, but how can it approve the review if it is not getting paid?

Gap with creditors grows, reputation harmed – Linked to the above, given that not paying the IMF is usually a course of action reserved only for war torn countries or those on the fringes of the international system, not to mention severly underdeveloped economies, Greece could see its reputation severely dented. Furthermore, it is possible that Greece’s creditors will see that Greece has decided to pay wages and pensions first rather than meet its commitments to them. Whether or not this is a fair assessment, this could drive further animosity between the two sides.

Market funding becomes even harder – At this point in time this might be largely irrelevant given that Greece is locked out of the markets for the foreseeable future in any case, but not paying the IMF would likely be the final nail in the coffin, ending hopes of returning to the markets soon even if some agreement is found with Eurozone partners. Usually, the move would also be expected to raise the cost of short term debt, but given that these go almost entirely to Greek banks who have little choice but to buy them the impact could be limited.

Possible default on Eurozone loans – Greece’s Master Financial Assistance Facility Agreement with the European Financial Stability Facility (EFSF) notes that it could be considered to be in default on the loans from the Eurozone if it

has overdue charges on outstanding purchases and the Managing Director of the IMF has notified the Executive Board of IMF that such repurchases or such payment of charges have become overdue.

Essentially, after one month, when Lagarde notifies the IMF Board about the overdue payments Greece can be considered in default on its EFSF loans as well. However, this is all carefully worded and qualified – it explicitly says the EFSF is “not obliged to” take such action. In the end, it seems to ultimately depend on the decision of the EFSF. It seems unlikely that it would declare the full loan to be in default. That said, pressure would rise within certain member states and national parliaments for some decisive action. Eurozone partners could also use this to further extract concessions from the Greek government. (The original bilateral Eurozone loans also include similar clauses).

Potential cross default on private sector bonds – Under the 2012 debt restructuring, the new Greek bonds which investors were given were issued under English law and included both ‘cross default clauses’ (meaning if they are considered to have defaulted on other obligations they also default on these bonds) and ‘co-financing clauses’ (money for repayments is to an extent pooled between the bonds and the EFSF). However, the latter looks to only apply to the EFSF loans rather than the IMF loans, while the former only explicitly refers to other restructured bonds (more on this in the update below). As such, default would have to be triggered on the EFSF as well for these to be activated and for default to be triggered with respect to the bonds. It is worth noting that the rating agency Fitch said in a recent statement that arrears to the IMF alone “would not in and of themselves constitute a rating default” but would be “credit negative” and lead to a further downgrade.

Potential cross default on ECB – The exact terms of the bonds held by the ECB (purchased under its Securities Markets Programme) is less clear since the swap was done in a much more secretive way to ensure the bonds were not captured by the 2012 restructuring. The ECB was issued new bonds under exactly the same terms and maturities. Reports suggest that the bonds remained issued under Greek law. It’s not clear if they include cross default clauses at all and, if they do, whether they would be applicable to bonds issued under English law and/or the loans.

ECB limits or cuts off ELA – It is uncertain then whether default clauses on any loans or bonds would be triggered. Even if they are not, the ECB may reconsider its provision of Emergency Liquidity Assistance (ELA) to Greek banks and would likely refuse to raise the limit further. As noted before, this is likely because of the huge reliance of Greek banks on the state – which would clearly be struggling for cash. Given that the very public act of not paying the IMF may further increase uncertainty and deposit outflows, the impact of limiting ELA could be exacerbated and cause a serious funding crunch for Greek banks and indirectly the economy and the state.

Overall, the short term impact of not paying the IMF may not immediately be dire in economic and financial terms, though of course it would involve serious reputational damage and further widen the already mammoth gap between Greece and its creditors. It may take a month before cross default clauses could be triggered and even then it rests with decisions of highly political institutions such as the EFSF. Such decisions would likely be managed to achieve the least controversial ends, but equally could quickly spiral out of control. Less certain is the response of the ECB, which would once again be the key player.

In the end, it would still not be advisable for the Greek government to test this course of action. We still expect a deal to be found, and largely on Eurozone terms.

UPDATE 16/04/2015:

As crunch time approaches and Greece runs short of cash once again, rating agency Standard and Poor’s has downgraded Greece to CCC+/C (full decision here). Similar to Fitch, cited above, S&P concludes that “a missed payment to an official creditor would not constitute a trigger to lower the rating to ‘SD’ (selective default)”. So the rating agencies seem to be putting some clear light of day between private sector and official creditors.

Expanding on the point above, the new Greek bonds held by private creditors do not include explicit and automatic ‘cross default clauses’ that would definitively be triggered by a missed payment to an official creditor (only clauses in reference to each other). But as noted above, the ‘co-financing agreement’ clause means that any alteration in the payment schedule to the EFSF or if the EFSF loan is declared to be in default and called in, would count as default for the private sector bonds (this seems to amount to a de facto cross default clause with regards to the EFSF). This of course is a political decision, and therefore not guaranteed, hence the rating agencies decision to put some light of day between the two sides. In the end, as suggested above, while not advisable, there is scope and room for a missed payment to managed in the very short term (a few months).