How to keep Greece in by Christian Odendahl
Greece’s economy is in dire straits after months of political mismanagement and brinkmanship, which culminated in the closure of the country’s banks, the imposition of capital controls and the threat of expulsion from the eurozone. Such limbo would be toxic for any economy, but especially for a highly indebted one caught in an economic depression and in urgent need of reform. What Greece needs, however, might not be politically feasible, on the part of the Greeks or the rest of the eurozone – in which case it is worth considering whether it is in Greece’s interest to leave the eurozone. The first essential condition for continued Greek membership of the eurozone is a functioning banking system. The banks, deemed solvent by the new single European supervisor in its balance sheet screening exercise in October, are dependent on emergency liquidity assistance (ELA) from the ECB. The reason is that Greek banks cannot sell illiquid assets such as corporate loans as fast as Greek customers currently want to withdraw money from their accounts. The ELA is intended to stop such bank runs, by providing liquidity against banks’ illiquid collateral – something that is at the heart of any central bank’s mandate. The problem is that Greek banks’ collateral depends in part on the solvency of the Greek government: some assets are tax credits, others state-guaranteed. The ECB took the political decision before the Greek referendum to stop increasing the ELA,
which forced the banking system to shut down. This has undermined confidence in the banking system, damaged consumption and investment, and made another recapitalisation of up to €25 billion necessary. Capping ELA was a very costly political threat that failed to impress: Greeks voted ‘Oxi’ to the creditors’ offer in any case. The longer the recapitalisation is drawn out because of lack of an agreement, the greater the damage to the Greek economy. What is more, it is still unclear what bank liabilities will be bailed in, apart from equity and unsecured bond-holders. If unsecured deposits are converted into bank capital, the Greek economy will take another blow. Unsecured deposits in banks are largely non-financial companies’ working capital. The recapitalisation must be done swiftly, and needs to spare deposits of any kind, to preserve what little confidence remains in the Greek banking system.