Once upon a time, merely suggesting that a Eurozone country may be kicked out, let alone suffer capital controls, was enough to get one sued by the Hague for crimes against humanity, if not outright droned. Now, and as has been the case for the past 4 months, that it is the Troika's explicit intent to foment a depositor panic and instigate a bank run in Greece with the hope of overthrowing the Tsipras government, everyone is allowed to chime in.
So, without further ado, here is what the next steps for Greece may be as well as a walk through of its capital controls, courtesy of JPMorgan.
Capital controls, ECB rules, and bellicose rhetoric
There are increasing media reports that capital controls are being prepared for implementation possibly as soon as this weekend should the discussions with Greece not generate a deal. This raises a number of questions about how capital controls would work, and how their imposition would effect the negotiation process.
The practicalities…
On some of the practicalities of capital controls, Cyprus provides a template, and we have written up some of the lessons from that experience in the research note linked to below. The table below, reproduced from an IMF program review, summarises the measures that were put in place in Cyprus and their subsequent removal. In this instance, capital controls should be thought of as a set of administrative constraints which seek to prevent deposits leaving the banking system while still attempting to allow “normal” economic activity to continue. Hence limits are imposed on the ability of households and firms to withdraw their deposits in cash, or to move them out of country concerned. Firms who need to transfer funds abroad as part of their normal business (consider, for example, a Greek auto dealer importing German cars) have to provide documentation to show those movements are indeed related to commercial activity rather than a portfolio shift.
And the politics...
The decision to impose capital controls ultimately lies with the Greek authorities, and would generate a need to pass legislation through the Greek parliament to give those controls the full force of legislative backing. A key issue is the extent to which the Greek authorities would cooperate with the rest of the region on imposing capital controls. Although the decision on capital controls is ultimately taken by Greece, decisions on the provision of funding to the banks are taken by the ECB. If the ECB decides to raise haircuts on collateral significantly, or not to raise ELA to meet deposit outflow, then the Greek banks will find themselves in a position where they cannot meet requests for withdrawals. The banks themselves would then either have to come up with a scheme for rationing access to deposits, or (more likely) shut their doors. The imposition of capital controls can be thought of as trying to make that rationing process orderly, with the denial of unlimited liquidity from the ECB the key force acting in the background. If that makes the ECB look like the bad guy, remember that from the point of view of the central bank and the rest of the region, each increase in ELA facilitates an increase in the region’s exposure to Greece via Target 2.
The ECB’s rules...
Against this backdrop, one can understand why yesterday Draghi was keen to state that the ECB is a rules-based institution and that the key decisions would be taken by politicians, not central bankers. On this, we will simply repeat what we have written before. If one thinks of rules in the sense of vaguely specified guidelines with scope for multiple interpretations at differing points in time, then Mr Draghi is correct that the ECB is rules based. The ECB might have hoped that the accumulation of precedent would create conventions about its behaviour through time. But there has been enough variation in how the ECB has handled specific situations for the idea of settled rules and conventions to be challenged. In the ECB’s defense, it has often had to think on its feet during the crisis, and many of the decisions it has taken have appeared reasonable to us in real time. In this particular instance, however, we doubt that the ECB will do anything without their being clear political backing from both the Eurogroup and from Merkel and other European leaders.
An anti-euro Tsipras?
There are reports that the Greek government is threatening action via the European Court of Justice should the region take action which inhibits bank’s access to liquidity and hence force the imposition of capital controls or the closure of its banks. We very much doubt any such legal action would be successful, and it would take a while before that case came to be heard. But more important is the signal that the Greek authorities may depict capital controls or the closure of the Greek banks as unjustly imposed upon them by the rest of the region. And meanwhile, the rhetoric from Tsipras is increasingly bellicose, with references to the “pillaging” of Greece, and of a need to avoid national humiliation.
One particularly ugly scenario would be if the Greek authorities resist the imposition of capital controls, claim that restrictions on bank access to liquidity have been unjustly imposed, and then seek to use the antipathy that creates among the Greek population to begin to argue toward an exit from the euro. This is a scenario we have accorded a low probability to, on the grounds that it is not clear that the Greek population would follow the script and regard the situation as primarily the responsibility of the rest of the region. But the increasingly hot rhetoric has us more concerned about this than we have been hitherto.
Note on lessons for Greece from Cyprus
