The situation in Greece has escalated meaningfully since last week. After the IMF effectively threw in the towel and sent its negotiating team back to Washington on Thursday, EU and Greek officials agreed to meet in Brussels over the weekend in what was billed as a last ditch effort to end a long-running impasse and salvage some manner of deal in time to allow for the disbursement of at least part of the final tranche of aid ‘due’ to Greece under its second bailout program. Talks collapsed on Sunday however as Greek PM Alexis Tsipras, under pressure from the Left Platform, refused (again) to compromise on pension reform and the VAT, which are “red lines” for both the IMF and for Syriza party hardliners.
By Monday evening it was clear that both EU officials and Syriza’s radical left were drawing up plans for capital controls and a possible euro exit with Brussels looking to Thursday’s meeting of EU finance ministers in Luxembourg for a possible breakthrough. That seems unlikely however, given that Athens is sending FinMin Yanis Varoufakis whose last Eurogroup meeting ended with his being sidelined in negotiations after putting on a performance that led his counterparts to brand him an amateur, a gambler, and a time waster. For his part, Varoufakis says no new proposal will be tabled in Luxembourg as Eurogroup meetings aren’t the place for such discussions, which is ironic because Jean-Claude Juncker said something similar not long ago when the Greeks were trying to get a deal done at the very same Eurogroup meetings.
Perhaps realizing that pinning everyone’s hopes on a Thursday breakthrough is a fool’s errand, the EU will reportedly convene a high level, emergency meeting over what we’ve suggested may be a “Lehman Weekend” for the market.
Against this backdrop the war of words heated up on Tuesday with Tsipras delivering yet another incendiary speech to parliament in which the PM claimed the IMF has “criminal responsibility” for trying to “humiliate an entire people”, which is ironic because if anyone should be humiliated here it’s probably the IMF given that Athens employed the old “one move and Greece gets it” routine to force the Fund to pay itself €730 million in May and now faces the uncomfortable prospect of being railroaded into disbursing €3.5 billion in doesn’t want to disburse so that Greece can make June’s payments which have already been delayed and which Athens now wants to put off for another six months. Meanwhile, Jean-Claude Juncker has dropped the “Tsipras is my friend” routine altogether, saying he “doesn’t care about the Greek government” but rather about “the Greek people.” Juncker (who once famously opined that "when it gets serious, you have to lie") took it a step further on Tuesday, blaming Athens for misleading Greeks: “I am blaming the Greeks for telling things to the Greek public which are not consistent with what I’ve told the Greek Prime Minister,” Juncker said. “Juncker either hadn’t read the document he gave Tsipras…Or he read it and forgot about it,” Varoufakis quipped, in a terse response. Finally, France’s European commissioner, Pierre Moscovici, brushed off Tsipras' contention that the troika's demands are "absurd," saying creditors' push for pension and VAT concessions is "far from crazy."
And while the politicians engage in one-up word battles and play an endless game of headline hockey, analysts, bankers, and economists are busy speculating on what capital controls and a Greek exit will look like. Here’s UBS:
It would not be the first time that capital controls have been introduced in the Eurozone – there is the precedent of Cyprus, which restricted capital flows between March 2013 and April 2015. Yet, importantly, in the case of Cyprus, capital controls were imposed as part of a Troika bailout with the aim of protecting the Cypriot banking system while it was being stabilised and restructured. In contrast, in Greece capital controls would be imposed in the absence of a deal – as a result of stalemate in discussions over broader issues of economic policy. Against this background, we worry that capital controls in Greece would be another step towards an uncertain course of events and possibly a harbinger of worse things to follow.
Relative to Cyprus, capital controls in Greece might also be more painful. Compared to Cyprus, Greece is a more closed economy (Greece's export quota is 33%, Cyprus' is 56% (2014)). A larger part of economics activity is dependent on domestic drivers and the economy can rely much less on trade driven currency inflows to finance external payments. As a result, recessionary dynamics are likely to get worse in the domestic economy (and potentially even in parts of the export sector). Exporters short in cash and reliant on bank credit would face difficulties to transact (this might include even part of the tourism sector). Import activity would gradually be rationed to the extent that outflows match the inflow of Euros from abroad. The domestic cash business would decline in size and financial conditions and lending activity will tighten. Counterparty risk would pick up domestically, with collateral in domestic sectors rationed by firms' capacity to generate cash. In addition to the cash constraints, heightened uncertainty would make economic actors very cautious (potentially affecting payment morale), thus restricting economic activity.
And from Bloomberg:
How would capital controls work?
They would hurt. No one knows the specifics for Greece, but here’s what happened in Cyprus: ATM withdrawals were capped at 300 euros a person per day. Transfers of more than 5,000 euros abroad were subject to approval by a special committee. Companies needed documents for each payment order, with approvals for over 200,000 euros determined by available liquidity. Parents couldn’t send children that were studying abroad more than 5,000 euros a quarter. Cypriots traveling abroad could carry no more than 1,000 euros with them. Termination of fixed-term deposits was prohibited, while payments with credit and debit cards were capped at 5,000 euros. Checks couldn’t be cashed.
How would capital controls be put in place?
An element of surprise helps. In Cyprus it started with a long bank holiday, between March 16 and March 28, 2013. That gave the country time to negotiate an accord with euro-area member states and the International Monetary Fund. Banks re-opened with restrictions in place and a recapitalization plan for the country’s financial system, which included the imposition of losses on deposits.
How long might it last?
There’s no real limit. Cyprus kept controls in place for two years, even though they were supposed to be a temporary emergency measure. Limits on transactions gradually eased over the two-year period, before being lifted completely in April 2015. Experience from other countries, including Iceland, shows that once in place, they can only be removed gradually, after a long period of time. Iceland’s government presented a bill this month to lift capital controls implemented in 2008.
But perhaps the most dire assessment came from the Bank of Greece, which warned on Wednesday of an “uncontrollable crisis” in the absence of a deal. Here’s more, from the press release:
Failure to reach an agreement would, on the contrary, mark the beginning of a painful course that would lead initially to a Greek default and ultimately to the country's exit from the euro area and – most likely – from the European Union. A manageable debt crisis, as the one that we are currently addressing with the help of our partners, would snowball into an uncontrollable crisis, with great risks for the banking system and financial stability. An exit from the euro would only compound the already adverse environment, as the ensuing acute exchange rate crisis would send inflation soaring.
All this would imply deep recession, a dramatic decline in income levels, an exponential rise in unemployment and a collapse of all that the Greek economy has achieved over the years of its EU, and especially its euro area, membership. From its position as a core member of Europe, Greece would see itself relegated to the rank of a poor country in the European South.
This is why the Bank of Greece firmly believes that striking an agreement with our partners is a historical imperative that we cannot afford to ignore. From all the evidence available so far, it seems that a compromise has been reached on the main conditions attached to this agreement and that little ground remains to be covered. Besides, the lowering of the primary surplus targets is a decision of paramount importance that significantly extends the time needed for fiscal adjustment and allows for additional degrees of freedom in the conduct of fiscal policy. Equally important will be the reaffirmation and articulation in more specific terms of our partners’ willingness to provide debt relief, as initially stated at the Eurogroup meeting of 27 November 2012. What we need today is a viable debt deal which will spare future generations burdens that we have no right to saddle them with.
To get an idea of how far apart the two sides are, consider the following from Tsipras (via Bloomberg):
“Our proposals fully ensure that we meet the budget targets that creditor institutions have set for 2015 and 2016,” Greek PM Alexis Tsipras tells reporters in Athens after meeting Austrian Chancellor Werner Faymann.
Savings of EU1.8b in 2016 alone from pension system aren’t possible; Greek proposals lead to savings of EU300m. There’s no room for additional pension cuts.
“Our proposals fully cover the extent of fiscal consolidation demanded, but Greece is a sovereign state. The Greek government has a recent mandate and it is its own competence to decide how to tax and where will it find themoney. The demand to find the savings asked from pension cuts is incomprehensible.”
“If Europe’s political leaders insist on this incomprehensible demand, they will assume the cost of a development which will not be beneficial for anyone in Europe.”
Government will assume responsibility to say “the big No” if no viable agreement is on the table.
And then of course there's the incomparable, incorrigible Mr. Schaeuble:
- SCHAEUBLE SAID TO TELL LAWMAKERS PREPARING FOR NO GREECE DEAL
If all of this sounds unequivocally bad to you and if it seems that capital controls and some manner of dramatic political and social upheaval are now an inevitability in Greece, you're not alone, but because we like to preserve our reputation for staying positive, we'll leave you with the following reassuring words from Tsipras:
"The real negotiations are starting now."