How a liquidity squeeze could push Greece out of the euro

Milan

THE stand-off between Greece and its creditors on how to proceed on its bailout programme risks triggering a simultaneous cash and credit crunch, which could drive the country out of the euro area.

Here is how a worst-case scenario could unfold: The Greek government, companies and lenders have all effectively lost access to international markets, due to the uncertainty over the country's future. The current sources of liquidity are bailout funds from the euro-area nations, the currency bloc's crisis fund, the International Monetary Fund (IMF) and the European Central Bank's (ECB) Emergency Liquidity Assistance (ELA).

Failure to strike a compromise means that these payments would cease. This means that the state would be unable to service its debt obligations, which stand at 22 billion euros (S$34 billion) this year, excluding treasury bills, according to the 2015 budget. Greek aid talks in Brussels ended abruptly on Monday.

"If the ECB considers the talks to have stalled, there is a risk that it will suspend ELA, perhaps leaving Greece with no choice but to exit the eurozone," said Jennifer McKeown, senior economist at Capital Economics Ltd in London.

Lack of access to bailout funds would also mean that the Greek state would not be able to repay its 15 billion euros outstanding of short-term debt held by the country's lenders. At present, Greek banks continuously roll over bills, helping the government stay afloat. The ECB decision not to accept Greek bills as collateral for financing operations and accelerating deposit outflows are limiting the ability of banks to buy new bills.

With no access to any source of financing, the insolvent state and its banks would have to start using a new currency, or a currency equivalent, as no economy can survive without cash. This would be the start of a de facto exit from the euro area, caused by Greece's inability to deal with a stripping of liquidity worth as much as 96 billion euros, according to Bloomberg calculations.

Commerzbank AG on Monday raised the probability that it assigns to a Greek euro exit to 50 per cent from 25 per cent after euro-area finance ministers' talks in Brussels broke down. Bank of America Merrill Lynch strategists, including Athanasios Vamvakidis, wrote in a client note on Feb 10 that the Greek government "can potentially get through the IMF payments in March, but would have difficulties after May".

There are 10.9 billion euros in European Financial Stability Facility (EFSF) notes, kept as a buffer in Greece's Financial Stability Fund, which can be used for bank recapitalisation purposes. If these funds are not requested for such use, or if there is no political decision on the eurogroup for other usage of this amount until Feb 28, then the buffer will be cancelled and returned to the EFSF, its director Klaus Regling has said.

In 2012, euro-area member states agreed to pass on to Greece the profits that their national central banks and the ECB made on their Greek bonds portfolio, subject to the condition that the country would abide by its bailout commitments. According to the latest IMF review of the Greek bailout, projected revenue from this agreement in 2015 and 2016 is 3.7 billion euros. Another 1.9 billion euros are still outstanding from 2014. These rebates are conditional upon "a strong implementation by the country of the agreed reform measures in the programme period as well as in the post-programme surveillance period", euro-area finance ministers said in November 2012. In other words, the country's creditors have no obligation to pass on these profits, if Greece rejects its bailout terms.

If Greece completes the last review of its current bailout, or asks for its extension, then it will be able to claim 1.8 billion euros still outstanding from the EFSF's commitments. The government has said that it plans to forsake this money, which is still on the table, as its disbursement is linked to belt-tightening measures and other conditions with which it disagrees.

Even though the euro-area-backed bailout expires on Feb 28, a parallel support programme by the IMF is set to run until early next year. BLOOMBERG

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