Eurozone to cut Greek Gordian Knot

The national central banks of the Eurozone that had Greek bonds in their portfolios have already exchanged them for new ones of the same face value, so that they will be excluded for the swap that’s soon to be realised under the Private Sector Involvement (PSI) plan to alleviate the country’s debt.

It should be remembered that, during the PSI exercise, all holders of Greek bonds issued until a certain date will be called to exchange them with new ones of a 50% reduced face value and, if they wish, they may receive 15% in cash. This is supposed to cut the Greek debt by €100 billion.

Eurozone central banks  
In more detail, according to information from Athens a number of Eurozone national central banking institutions, members of the European Central Bank (ECB), hold in their portfolios Greek bonds of a nominal value of €15bn, which they have bought in the secondary debt market at discounts of around 30%.

Last week’s exchange produced windfall profits for those central banks to the tune of €4.5bn at the expenses of the poor Greek taxpayers. Given however that those monetary policy institutions are not there to make profits on the back of Eurozone citizens, they are expected to return this profit of to their shareholders, that is the 17 Eurozone governments, who in their turn are expected to transfer it to their Athens peer, the Greek government, with nothing in return.

In this way, Greece can start cutting down its sovereign debt, just hours ahead of the initiation of the PSI project.


Coming to the PSI, its kick start has to be initiated by the Eurogroup of today 20 February, along with the whole Greek bailout project which contains at its centre the €130bn package of soft loans to save the country from a disorderly bankruptcy in March, when a huge bond of €14.4bn expires.

Greece cannot repay this obligation without the help of the EU-ECB-IMF troika,  a triangle scheme of official institutions that have undertaken to cover the financial needs of Greece over the past two years and are expected to extend their presence in this country to at least 2015.

In any case, this step by those Eurozone central banks to exchange their Greek bonds is an infallible sign that the whole operation to conclude this much expected in capital markets ‘Greek deal’, will be authorised this afternoon.

To this effect, Greek Prime Minister Loukas Papademos has already arrived to Brussels and he is supposed to meet the EU leadership on 20 February. Later on the same day, he is to reassure Greece’s 17 finance ministers that the country has already honoured her part of the deal, by having voted in favour in the Athens parliament last week of Draconian law ordering new cuts on wages and pensions and introducing far-fetched deregulation measures on the Greek labour market.

The ECB 
Coming back to the central banks, the step taken by some constituents of the ECB national banks last week means obviously that the ECB itself will indirectly participate in the effort to alleviate the Greek debt using with its own portfolio of bonds of a nominal value of €50bn.

Those bonds were bought also in the secondary market at a reduction of around 30%. If the ECB does the same as its constituents the final cut of the Greek debt from this operation may be anything around €15bn. This sum together with the cut of €4.5 after the national banks’ steps may well cover the ‘orphan’ part of the Greek debt estimated at €15bn.

This ‘orphan’ part of the Greek debt is the residual sum of the debt after the PSI operation, which is expected to reduce it to 128% of the GNP by the year 2020. This must be seen in relation to the 120-124% of the GNP which is considered to be the sustainability threshold for the sovereign debt for every country. Those 4-8 percentage points or a round some of €15bn is supposedly the part of the Greek debt that is not accounted for by the overall aid package to Greece of €130bn, and needs to be covered.

The reason for this is that the IMF cannot keep on supporting a country with a sovereign debt above the level of 120% of the GNP. So in order for the IMF to continue being present in the Greek deal the overall support exercise must reduce the level of the debt to the manageable levels of 120% of the GNP.

There are a few options to enable this, the most obvious of which is firstly to use the proceeds of Greek privatisations to cut down the country’s debt or increase the rest of the Eurozone countries participation to the entire package above its present level of €130bn.

Given however that there is not time for that the only feasible solution now appears to be a decision by the ECB to do the same with its portfolio of Greek bonds as its constituent Eurozone national central banks did.  Another obstacle for the realisation of the Greek deal was the German reserve about the political scenery in Greece, after the next election set for 29 April.

The reserve was related to the possible outcome of the election, with the three left parties which have rejected the entire Greek deal in parliament and the streets of Athens expected to win 42% of the votes, thus making even harder for every Greek government to honour its obligations vis-a-vis the €130bn package and prioritise debt payments.

Political reserves
On 17 February, New Europe wrote: “Eurozone decision makers, under pressure from markets, appeared ready on 17 February to release the €130 billion package of soft loans to Greece.  This is expected to take place during the Eurogroup meeting of 20 February, in order that Athens avoids a disorderly bankruptcy in mid-March, when a huge bond of €14.5bn needs to be repaid.  Without EU help, Athens cannot repay this bond. To achieve this, it expects its Eurozone peers to release the much-needed funds on 20 February, under a second Memorandum of Understanding (MoU), as agreed during the European Summit on 28 October.  This package contains a Private Sector Involvement (PSI) agreement with the country’s private lenders, expected to reduce the Greek debt by €100bn, along with the new soft-loan package. The realisation of the PSI exercise needs at least €30bn over the next three weeks – the money will finance the cash part of the agreement with the banks.  As for the participation of Greek banks in the PSI operation, this will leave the country’s banking system in need of recapitalisation, which will amount to around €20bn, a sum that is also supposed to come from the overall €130bn agreed between Greece and the EU-ECB-IMF troika.  However, the release of the funds has been questioned over the past few days, mainly Germany and its Finance Minister Wolfgang Schäuble, who appeared uncertain over the ability, or even the willingness, of Greece’s political class to honour the country’s part of the bargain, which will involve the application of a Draconian austerity plan to be implemented over the coming years.  Schäuble said that he was particularly worried about the Greek political situation after the next general election, which is set for the end of April. Germany has been joined by Finland and the Netherlands in casting doubt on the Eurozone’s ability to find a way out of the crisis.  The three countries have advanced a controversial version of the Greek deal, proposing to break the package in two; releasing now only those funds needed to avoid Greek bankruptcy and then impose an overview on the Athens government’s expenses, making sure that the country’s budget priorities are the debt payments, in an obvious attempt to place the country under German financial surveillance.  This is quite different from the usual quarterly controls of the Greek economy by the troika of its official creditors, which were routinely realised before the release of more funds. The new German proposal also presents major political, legal and operational problems. The idea behind the new German reserves is that the present political order in Greece, with its two major parties PASOK and New Democracy guaranteeing that the country fulfil its part of the deal, may change after the election.  For one thing PASOK, today’s leading power in the parliament, is now ranked fifth in the polls with only 8-13% of citizens saying that they will vote for the party in April. The two parties lost 20 deputies each in the crucial parliamentary vote of 12 February, when the house of 300 endorsed the new austerity plan with a 199 majority…  In short, under pressure from markets and major countries outside the EU such as the US, Berlin is again changing course. Reportedly Thomas Steffen, the German under-secretary of finance, said on 17 February that the PSI exercise in favour of Greece will be launched on 22 February, meaning that the Eurogroup scheduled for 20 February will release the package. So, it seems that the markets were not wrong to appear optimistic and record gains, following a negative Thursday when even New York’s Wall Street could not capitalise on the good news from the US employment market, and ended up in the red. 

“Last but not least, the Greek deal seems to be short of €10-15bn, according to the debt projection by the European Commission and IMF experts. It must be remembered that the IMF considers a country’s debt as sustainable up to the benchmark of 120% of GNP. In Greece’s case, this projection estimates that the debt will be around 128% of GNP by the year 2020, thus marking it as non-sustainable and sending the entire deal to a dead end – the IMF cannot continue financing a country with debt that is not sustainable. 

“To repair this default on the deal, the European Central Bank is expected to participate in the entire exercise (not in the PSI) with its portfolio of €50bn of Greek bonds, but not directly helping Athens. In any case, this is the easy part of the deal, once Germany gives a green light for the entire package.” 

Escrow account
As a result of all those difficulties in the realisation of the Greek deal Germany appeared some time this past week to favour a break-up of the package into two parts. One, to cover the immediate needs for the realisation of the PSI plus the money needed to recapitalise the Greek banks. That comes to a round some of €70bn.

Given, however, that the largest part of the package is needed immediately and that the break-up might encounter political difficulties both within and outside Greece, Germany has now abandoned the idea of the break up and is now focusing on making sure that the Greek side will honour its obligations.

This is expected to be done in two ways – for one thing, there will be the regular quarterly examinations of the Greek economy by the troika and the release of more money from the overall package may be bonded to the outcome of these examinations.

Secondly, the ownership of the entire package of €130bn will not be transferred to Greece, but will be deposited in an escrow bank account and the release of more money from it will be bonded once more to the relevant troika decisions. In this way, the Eurogroup is expected to cut the Greek Gordian Knot.