While the clock continues to wind down towards the June 30th deadline payment and Greece hopelessly tries to pull itself out of a full-blown depression, its liquidity position continues to deteriorate under the burden of a crushing debt, and no matter how many spending cuts are enforced, turning around the economy back into healthy growth seems to be like mission impossible.
The experience of the last five years suggests that buying more time is anything but helpful; it may seem like a better short-term option when compared to an immediate Greek default and euro exit, however in the medium to long-term, it only contributes to deflationary pressures, ballooning deficit and the sky-rocketing public debt-to-GDP ratio.
Greece’s Achilles’ heel is the country’s banking system, which has been kept on life support by the European Central Bank during the last few years
Sunday night’s yet another attempt to get a technical agreement in place before European markets opened on Monday morning, collapsed in less than an hour, with Greek proposals remaining incomplete, according to the official creditors’ opinion, and with no deal on bailout aid, Greece pushes ever closer to default. A fairly wide divide exists with respect to the level of primary surplus and how Greece should achieve the necessary savings through spending cuts.
The promise to the Greek People
In effect, Greece has been asked to come up with an extra 2 billion euros annually, mainly through pension cuts, increase in VAT and taxes. This requirement, however, is in contradiction with the promises that the government made to the Greek people a few months ago during the election period, and conceding to such reforms in order to reach an agreement and avoid default, may force a referendum or even new elections.
This came as no surprise, after last Friday, when the IMF walked out on debt negotiations as a result of becoming totally frustrated with technical as well as political talks being at a deadlock, declaring “Game Over”.
Standard & Poor’s rating to ‘CCC’ from ‘CCC+
The day before, Greece’s long-term sovereign credit rating was cut by Standard & Poor’s to ‘CCC’ from ‘CCC+’, reflecting the institution’s opinion that in the absence of an agreement between Greece and its official creditors, the Greek government will likely default on its commercial debt within the next 12 months.
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Strictly speaking, a technical default has already occurred in Greece by choosing to defer its June 5th debt payment to the IMF, and bundle all of the payments due this month into one lump sum of 2.7 billion euros at the end of June.
Are we close to a bank failure in Greece?
A missed payment to an official or bilateral debt obligation between a government and the World Bank or the IMF is not considered to be a default event according to S&P, as it is associated with financial contracts that tend to have a political rather than a commercial character. It is however considered as another sign of the lack of liquidity and it is a matter of time before commercial creditors experience a default as well. Inability to repay commercial creditors, on the other hand, such as bond holders or banks, would be considered as a default.
Greece’s Achilles’ heel is the country’s banking system, which has been kept on life support by the European Central Bank during the last few years. Without a properly functioning banking system, the country’s collapse is inevitable.
Moreover, there is reputational and financial risk for the ECB
Are we close to a bank failure in Greece? Banks have been experiencing a steady decline in deposits, with a constant need for liquidity in order to meet ongoing withdrawal requests from their depositors. A bank run could be triggered in the short-term, depending on the outcome of the negotiations and whether another tranche of payments can be secured.
If Greece defaults, is the Eurozone ring-fenced against such an event or is there contagion risk? Several measures have been taken to minimize a contagion risk, both on a regional and a national level, however such a risk cannot be completely eliminated, as this is an uncharted territory and the geopolitical ramifications could be detrimental for member states as a whole. The situation is extremely complicated, as it appears that there is no common view in terms of what has happened so far, and most importantly what steps must be taken going forward. As a result, policy makers seem to be losing control of the situation and the reputational risks for Europe are quite high.
Moreover, there are reputational and financial risks for the ECB over the amount of liquidity assistance being provided to Greece. The most crucial deadline is in July, when Greece will have to make a bond repayment to the ECB, amounting to over 3 billion euros, which will be impossible unless a deal is reached during the current negotiations. If the deadline is missed, the ECB will no longer be able to provide emergency liquidity assistance to the Greek banking system, resulting in the reputation of the ECB being severely tarnished.
Focus now shifts to the 18th of June, when a new Eurogroup meeting will take place in Luxembourg and there will most likely be a “take it or leave it” deal. If such a deal is secured this Thursday, it will allow sufficient time for different parliaments to approve it in time for Greece to receive the necessary funds by the end of this month. While global markets have been quite complacent so far over the Greek crisis, the sentiment is now shifting to negative across the board from Asia, to Europe and the US, as it becomes more likely than ever for Greece to default and exit the Eurozone.