Are Greek banks improving or struggling for liquidity?

Those who followed our analysis of the Greek bond buyback will remember that we warned at length that it could have some adverse effects, one of which would be to hit bank liquidity at a time when Greek banks could least afford it.

In the end Greek banks were pushed to take part by the government but their resistance (despite being reliant on the Greek Central Bank for liquidity and the eurozone for a recapitalisation) was quite telling.

In any case, data is now beginning to emerge which sheds some light on the issue but also provides plenty of questions (as always with Greece data releases are some months behind elsewhere so the latest data available is for January 2013).

Greek bank borrowing from the ECB and the Greek Central Bank (via ELA) has dropped significantly since the bond buyback at the start of December (down €21.3bn since November 2012).

 

Now, normally a sharp drop in borrowing from the ECB and ELA would be a positive thing since it suggests reduced reliance on official funding. However, in this case, we suspect that rather than improving their position, banks are actually struggling to find sufficient assets to post as collateral with the Bank of Greece to gain liquidity.

Other factors do support this argument. The Bank of Greece annual accounts show that the overall collateral pledged for central bank liquidity fell by €11.7bn in the aftermath of the bond buyback, while borrowing from the central banks fell by €7.5bn (data for January is not yet available). Furthermore, with total assets pledged for collateral still totalling €217.1bn or 50% of all bank assets in Greece it is easy to imagine that the banking sector is working under significant collateral constraints.

Are there any other potential explanations?

Well, the first would be that banks repaid their borrowings from the ECB’s Long Term Refinancing Operation (LTRO) in January. This seems very unlikely. The LTROs coincided with a period of extreme turmoil in the Greek banking sector due to the Greek debt restructuring, a period in which Greek banks could not access the ECB. Therefore, it is unlikely that Greek banks borrowed much if anything from the LTRO. Besides, if they did, it seems strange that they would give back a key source of long term funding early.

The second explanation could simply be that confidence has returned somewhat. There is some evidence to support this, not least the return of domestic deposits, which have increased by €12.1bn since November 2012. However, that still leaves a drop in central bank borrowing of €10bn which does not seem to have been filled by other sources of liquidity.

Lastly, the bank recapitalisation is being enacted, which could reduce the Greek bank demands for liquidity, although since it isn’t expected to be completed until end of April it would seem strange if the impact showed up this early on.

Overall then, there seems to be some strong evidence that the Greek bond buyback has hit the liquidity access of Greek banks, albeit not in a catastrophic way. More importantly though it has happened at a time when credit provided to the real economy continues to contract and economic growth remains some way off.

Update 16:30 13/03/13: 
@EfiEfthimiou has flagged up a good point over email. In December 2012 the ECB began accepting Greek government bonds as collateral again, this allowed banks to switch from using the more expensive ELA to standard ECB liquidity. The haircut on collateral may also be lower under standard ECB lending (we can't be certain since ELA terms are secret). This could have allowed the banks to reduce their liquidity needs and the level of collateral posted - another potential explanation then.

ECB publishes details of SMP purchases

The ECB has just released details on its holdings of government bonds bought under the Securities Markets Programme (SMP) for the first time, see table below (click to enlarge):

To be honest, the figures are much as expected – although the holdings of Greek bonds will have decreased due to a fair amount of the holdings maturing (circa €10bn over the course of the SMP). The holdings of Italian bonds are interesting, given that we knew the ECB purchased almost €145bn of Spanish and Italian bonds, it is possibly a bit surprising that the level of Italian bonds outweighs Spanish so significantly (although it does broadly match the relative size of their debt markets). Still it highlights that necessary intervention to simply keep yields in these countries to below 7% was still very sizeable.

The move is positive for the transparency of the ECB (if a little late). Let us hope this is the start of a trend rather than a one off…

Celebrating the end of the eurozone affair ignores the heart of the matter

In today's Telegraph, Mats Persson seeks to answer this simple - and yet brutally complex - question: is the eurozone crisis over?

'We are in the middle of the beginning of the end. The crisis has really hit its peak”, former French economy minister and current IMF chief Christine Lagarde told a broadcaster when asked about the eurozone crisis. The only problem: that was in July 2010. Time and again, EU leaders have declared the crisis over – and been proven wrong. So with markets remaining cautiously optimistic about the euro, is the worst finally behind us?

There are well-rehearsed reasons to be cheerful. Borrowing costs are down for all crisis-stricken countries, exports are picking up in some and EU leaders have actually agreed on a forward-looking measure by turning the ECB into a single supervisor for eurozone banks. Just as eurozone leaders have celebrated prematurely, Anglo-Saxon analysts have consistently tended to overstate the immediate risk of a eurozone break-up. Famously, one major US bank last year assigned an 80pc-90pc risk of Greece leaving the euro – an assessment that Open Europe cautioned strongly against. In Europe, the safest money is always on another fudge. Germany and the ECB were likely to take a political decision to keep Greece inside the eurozone for now, given the fragile situation elsewhere.

But the news last week that the eurozone economy shrunk by 0.6pc in the last quarter of 2012 illustrated what was always the bloc’s greatest challenge: reversing chronic economic malaise. Most fundamentally, reconciling a supranational currency with 17 national democracies remains a challenge. The eurozone’s basic austerity-for-cash prescription continues to fuel tension within individual countries and between the hawkish north and the austerity-fatigued south, testing voters’ patience. The forthcoming Italian elections are turning into a bit of a referendum on EU-mandated austerity, just like the Greek elections last year. Five of the seven main political parties – together polling at around 50pc – have vowed to end cuts. Two parties, Lega Nord and the Five Star Movement, the latter led by comedian-cum-politician Beppe Grillo, even want a referendum on whether the country should remain in the eurozone. The everlasting Silvio Berlusconi is making last-minute gains, in part thanks to a promise to kill what he calls “austerity imposed by Europe”. Against all known principles of common sense, the man still could win. Thankfully, a broadly pro-reform, centre-left coalition led by Pier Luigi Bersani is the most likely outcome, but even then the hope of sweeping economic reforms will be tempered, not least due to those parties’ strong links to the unions.

The Italian elections show how the north and Club Med in many ways are locked into a Catch-22: one wants cash (“solidarity”) first, supervision or discipline second, the other the exact opposite. That dynamic is again evident in the ongoing difficulties in agreeing a bail-out for Cyprus: Germany is unwilling to put in cash for fear of rewarding the bloated Cypriot financial sector. Cyprus resists far-reaching privatisations or significant write-downs of its banking or sovereign debt. This north-south stalemate could become further entrenched if French president Francois Hollande continues to slide towards the Mediterranean bloc, both in terms of political temperament and growth rates (France registered zero growth in 2012). This would weaken the Franco-German axis.

And beyond politics, has the eurozone’s triple crisis – fiscal, banking and competitiveness – really been addressed in any fundamental way? Many eurozone countries are on the path to running a primary surplus – meaning income exceeds outgoings, excluding the cost of servicing a country’s debt. But the eurozone’s overall debt still stands at 90pc of GDP, compared to 70pc in early 2010. Greece, Italy, Portugal and soon probably Cyprus, have debt levels exceeding 120pc of GDP – double what is meant to be allowed under eurozone rules.

The banking sector, too, remains fragile. Thankfully, ECB action helped avoid a massive bank funding crisis last year, but there is a price: eurozone banks have become alarmingly reliant on artificial life support. Liquidity from the ECB to banks now tops €1 trillion (£860bn) – up €140bn on 2009. Even though some banks have started to pay back the cash they owed the ECB early, the eurozone is a long way off a back-stop to allow for wind-downs of bust banks or disentangling of bank and government debt. Overnight interbank lending – a key indicator of banks confidence in the system – remains only half of what it was in 2009 and a third of its peak in 2007. If the crisis were solved, this would surely not be the case.

Finally, by almost every indicator, the single currency is absolutely riddled with economic imbalances, but with no fiscal facility to compensate for them. Encouragingly, Spain, Portugal and in particular Ireland have cut unit labour costs relative to Germany – a key measure of competitiveness - but Italy and France are actually becoming less competitive in relative terms. And imbalances go far beyond labour cost. This year, Greece is expected to contract by over 4pc, Spain by 1.5pc and Cyprus by almost 2pc – while Germany, Finland and others are set for growth. Then there is unemployment. Shockingly, Greek unemployment hit 27pc towards the end of last year, with youth unemployment close to 62pc. Spain is not much better at 26pc and 55pc respectively – and all the scheduled reforms and cuts haven’t even been implemented yet. In Germany, meanwhile, unemployment is at record lows.

In a best-case scenario, the Mediterranean countries will follow the Irish example and continue to squeeze wages and cut costs at home. But in light of domestic political resistance, these imbalances could well continue to test the eurozone’s one-size-fits-all model for a very long time.

So, we have an election fought over EU austerity, political stalemate, a bail-out which no one wants to pay for, abysmal growth forecasts and massive unemployment. There may come a day when the eurozone bounces back and puts us all to shame. But to celebrate now the “end of the crisis” seems to be setting the bar exceptionally low.

Another unwanted record in the eurozone...

Yesterday’s unemployment figures from Eurostat made a surprisingly big splash in the European press today. We say surprising since for anyone following the crisis this has been a longstanding and deeply concerning trend in the eurozone.

Eurozone unemployment reached a record high of 11.8% in November (up from 11.7% in October), while youth unemployment reached the staggering level of 24.4%, meaning almost a quarter of young people in the eurozone are out of work.

Looking deeper at the data, there are a few important points to consider:

The current trend runs counter to the majority of forecasts by the Commission and the IMF. We’ve discussed this before with regards to Greece, but it also holds for Spain, Portugal and many others. Although the pace of increases in unemployment is slowing, it has not yet stopped and with austerity set to continue across the eurozone it seems unlikely to do so at any point this year. Despite this, many of the forecasts show unemployment stabilising at or near current levels – this data highlights that this remains unrealistically optimistic.

There remains huge divergence between the stronger and weaker countries. With Austria posting unemployment of 4.5% compared to Spain’s 26.6%, the talk of the eurozone crisis being over seems rather pre-emptive. Fundamental divergences remain between the countries, with no clear mechanism for correcting or managing them yet being discussed at the highest level.

The increase in long term unemployment is becoming increasingly concerning. In the second quarter of 2012 it reached 5.2% in the eurozone, but topped 13% and 10% in Greece and Spain respectively. This has the ability to significantly harm the potential productivity of these economies and become a significant drag on (already low) economic growth. As with the wider figures it drives home the need for strong structural reforms, particularly to education and retraining programmes.

It’s also worth keeping in mind that this is happening at a time when growth is stagnating and public spending is falling sharply, meaning that the fall in standards of living for many people could be substantial – as we have pointed out before this has the potential to be a toxic mix in what is already a very politically divisive crisis.

Greek bond buyback fallout continues

As we noted in this morning’s press summary, there have been some interesting developments with regards to the Greek banking sector.

Kathimerini reported that, according to unnamed bank officials, the bank recapitalisation may now need to be larger than the scheduled €27.5bn. The reason for this is twofold:

• First, the level of non-performing loans in Greek banks topped 24% of all loans at the end of 2012. This is a staggering amount. Keep in mind the Spanish banking sector, which has been the focus of so much uncertainty, still has non-performing loans equal to around 11% of all loans. Greece once again is in another league here.
• Secondly, as we warned at the time, the bond-buyback had a detrimental effect on the Greek banks. Even if they did not take substantial direct losses on the bonds they submitted, they have lost out in terms of future revenue (the interest from the bonds). This is reported to amount to around €1.5bn this year.

As FT Alphaville highlights, this seems a fairly clear-cut case of the negative trade off which we highlighted at length in the run up to buyback.

Needless to say, it is not make or break and the marginal effect of the buyback is still positive, albeit fairly small in the scheme of the Greek crisis. Fortunately, there is an additional €5bn set aside for such ‘unexpected’ increases in the bank bailout, so the additional cost should not disrupt the bailout programme.

We would note as a final point, that this may not be the end of the story (not just because the non-performing loans are likely to increase further) but also because we are yet to find out what impact the bond buyback had on the Greek banks’ ability to access liquidity (an issue we discussed in detail here). Again it may not be make or break, but we suspect it could be a further negative factor for Greece to deal with - something it hardly needs.

Open Europe in 2012: a short summary of our achievements and a review of our eurozone predictions

2012 has been an important and very successful year for Open Europe, with Prospect Magazine judging us “International Affairs” think-tank of the year in recognition of our research and analysis’ increasing influence in the UK, Europe and beyond. This year, many of Open Europe’s research publications and ideas have had a direct influence on policy and decision making regarding the UK’s relationship with the EU.

We also hosted prominent figures from the world of politics, economics and business in our 2012 events programme, discussing a range of topics from the UK’s future role in Europe, Anglo-German relations to the finer points of the eurozone crisis. Perhaps the icing on the cake, in October this year, was the launch of a new independent partner organisation in Germany, Open Europe Berlin gGmbh.

To read the full review of our year, click here. Below we would like to focus on some of the predictions we made about the eurozone over the last 12 months (always a dangerous undertaking). Here is how we fared in predicting some of the key developments:

The bailouts for the Spanish banking sector and Spanish regions: In April, Open Europe’s Head of Economic Research Raoul Ruparel argued that Spanish “banks may be forced to tap the eurozone bailout fund” and highlighted that the build-up of debt by Spain’s regions would mean that they too could require bailouts. In June, Spain announced that it would request €100bn from the eurozone’s bailout funds to recapitalise its banks, while in July, several Spanish regions requested bailouts from the state which sent sovereign borrowing costs to record highs.

Second Greek bailout falling short...: In March, Open Europe predicted that, coming in at just 2% of GDP, the debt write-down of Greek debt under the country’s second bailout would be “far too small to allow Greece any chance of recovery”, with further assistance required in the future. In July, it became apparent that the second bailout had failed and in October, Greece received a two-year extension to its bailout programme, duly confirmed in late November. 

...but with Greece staying in the euro for now: While others put the risk of Greece imminently leaving the euro at 80%, Open Europe’s Mats Persson argued in January 2012 that “I doubt eurozone leaders will have the nerve to force Greece out this year.” 

Credit rating of France and eurozone bailout funds downgraded: In January, we predicted that “France could well be downgraded at least one notch…this would [also] hit the creditworthiness of the euro bailout funds”. On January 16, S&P downgraded France’s triple A rating, with Moody’s following suit on November 19, and on November 30 it also downgraded the eurozone’s two bailout funds.

LTRO would run out quickly: In December 2011, in a briefing looking at the potential impact of the ECB’s programme bank liquidly provision (LTRO), Open Europe’s Raoul Ruparel argued that while it may be welcome in the short-term, “hopes, and plans, that this funding will lead to a boost in purchases of sovereign debt look misguided.” By the summer of 2012, both Spain and Italy were seeing their funding costs rise quickly, and eventually the ECB would have to take additional action. 

Monti would struggle to fundamentally reform Italy’s labour market: In March, Open Europe’s Vincenzo Scarpetta warned of the risk that Mario Monti’s lack of a popular mandate could undermine his efforts to reform Italy’s labour market. With Monti set to step down in the coming months, the OECD has recently highlighted that Italy has undertaken limited labour market reforms, with its labour costs now amongst the highest in the eurozone. 

So not a bad record for 2012, click here to check out our predictions for 2013.

What to expect from the EU in 2013

As 2012 draws to a close Open Europe has put out its take on what to expect from 2013. Reviewing our (admittedly milder) effort at this last year, shows that we didn’t do too badly, especially for what turned out to be a very volatile and difficult year for Europe (with plenty of government interventions, which are notoriously hard to predict).

See here for the full report where we lay out our view on three key topics to watch in 2013 – discussions of a ‘Brixit’, the formulation of the new eurozone banking union and, of course, the continuation or otherwise of the eurozone crisis.

Section 1: The eurozone crisis – survival but stagnation

2013 looks likely to be a calmer, but still painful year for the eurozone, with several political flashpoints (notably German, Italian and Austrian elections) that could quickly trigger a fresh flare-up in the crisis – particularly as many of the campaigns could become de factor judgements on the eurozone crisis and the bailouts. The eurozone is unlikely to fully turn the corner, with low growth and high unemployment continuing to plague many countries. Activism from the ECB is likely to help ease concerns, with its new bond buying programme the OMT potentially activated to aid Spain at some point. This will be needed as markets will still be on edge with Italy, Spain and France face funding costs of €332bn, €195bn and €243bn respectively.

Section 2: Banking union – slow or even slower?
A decision on the second step of the banking union – a joint fiscal backstop – is unlikely to be taken amid continued disagreements and domestic pressures. Even plans to have the ESM recapitalise banks already look to have been pushed back to 2014. During the year it may become increasingly apparent that, as is, the banking union does not represent a solution to the crisis.

Section 3: Britain in the EU – a mid-life crisis or full divorce?

We don’t see any fundamental changes to the relationship, but positioning and political manoeuvring will set the stage for the 2014 (European Parliament) and 2015 (General) elections – that in turn could decide the exact nature of the EU-UK relationship in the future. Two important issues to watch will be the opt out (and back into) EU crime and policing laws as well as the negotiations on the EU budget. The general tone of the debate within the government and Conservative party will be an important test ahead of the elections.

Obviously then, this is far from an exhaustive list but simply represents our thoughts on some key points of interest to watch in 2013. Feel free to share your thoughts for 2013 in the comments below!

The Greek bond buyback: Greek banks are putting up a fight (as we predicted)

As we predicted two weeks ago the Greek bond buyback is turning out to be much trickier than almost everyone else expected, and for exactly the reason we suggested – the Greek banks.

Despite positive declarations throughout last week that the Greek bond buyback would reach its target of €30bn bonds submitted by the Friday deadline, the Greek government has announced that the deadline has now been moved to 12pm Tuesday 11 December.

Throughout the buyback process the Greek banks have made it clear that they want to keep their participation to a minimum and are not keen on the buyback plan generally. The reasons for why have been discussed here and here (potential losses and hit to liquidity). Needless to say, the Greek government has exerted significant political pressure to ensure that the Greek banks do participate fully.

Despite this, Kathimerini reports that the Greek government decided to extend the deal after hedge funds submitted €16bn in bonds (much of which they will make a profit on) while Greek banks submitted around €10bn. This was short of €16bn which the banks were expected to submit, and which they are likely to be pushed into submitting by tomorrow.

As FT Alphaville highlights, this did not go down too well and the press release on the extension contains a (very thinly veiled) threat that those bond holders who do not take part may not end up getting paid back at all. Stelios Papadopoulos, the head of the Public Debt Management Agency, is quoted (in the actual press release) as saying:

“Investors should bear in mind that even if Greece accepts all bonds tendered in the Invitation, it will continue to engage with its official sector creditors in considering further steps to put its debt on a sustainable path. Future measures may not involve an opportunity to exit investments in Designated Securities at the levels offered for this buy back.” 

The buyback still looks likely to be completed, but all of this highlights just how weak Greek banks are - the last thing the Greek economy needs is even weaker domestic banks (and therefore even less lending to the real economy).

Greek banks and the Greek bond buyback

Yesterday we put out a flash analysis looking at the latest Greek deal and the prospect of Greek bond buyback. One of the many issues with the deal (and the buyback in particular) which we raised was that Greek banks will find it difficult to participate without needing extra capital.

However, Greek Finance Mininster Yannis Stournaras also said yesterday (in a timely statement):

The debt buyback "doesn't mean new capital for banks, given that they have recorded these bonds at lower prices than those that will be offered."

His suggestion then, is that the Greek banks have already marked their bonds to market prices on their books, meaning that they can sell them at the low prices involved in the bond buyback without needing new capital. This may make their participation more likely, but there are plenty of other reasons why we still see it as difficult and unpredictable. (We also still question why foreign holders will be involved, particularly previous hold outs and those who are holding to maturity, see our full analysis here).

Firstly, as Kathimerini reported today, the banks themselves are not keen to be involved in the buy back. Many feel that they have already done their part in terms of taking part almost ubiquitously in the first debt restructuring. If they were to take part in the buyback, they could seek adjustments in the terms of the recapitalisation and reform – something which the EU/IMF/ECB troika is unlikely to accept.

Secondly, taking part in such a scheme would need significant approval within the banks and other financial firms. This means board level and possibly wider shareholder approval. As the restructuring earlier this year showed, this takes time, with the process dragging for months. Given the 13 December deadline to have a bond buyback plan in place (i.e. to have a firm idea of who will take part, to make sure it is worthwhile) it is not clear how many bondholders will be in place to participate.

Thirdly, and possibly most importantly, is that the banks need their holdings of bonds (around €22bn) to gain liquidity from the Emergency Liquidity Assistance (ELA) through the Greek Central Bank (GCB). Looking at the GCB balance sheet, it seems broadly that Greek banks posted €247bn in collateral to gain €123bn in liquidity, an average haircut of 50%. Given that many of these assets will be loans or securities, sovereign debt (even Greek) is unlikely to be judged any more harshly than the average. So, if the banks sold these assets for a 65% write down (as suggested) they could purchase new assets (maybe other sovereign debt) but would be able to buy less of it (as not many other assets priced at a 65% discount) meaning they would not be able to gain as much liquidity under the ELA as with current Greek bonds.

Essentially, this could harm the Greek banks liquidity position which would further constrain their lending ability and possibly prompt further deposit flight – both of which would hurt the fragile Greek economy.

All in all then, this process could still be counterproductive for Greek banks even if they do not book new losses directly and they still could be hesitant to take part voluntarily. However, that is not to say that the political pressure applied behind the scenes will not be enough to force them to voluntarily join. Ultimately, it simply highlights that this policy may deliver a small benefit with some negative side effects but is at best a way of skirting the real issue of whether the eurozone can stomach permanent fiscal transfers to Greece. This will come to the fore again soon.

Buying back Greece: another ad hoc deal or a step towards a solution?

Early on Tuesday morning the eurozone and the IMF reached an agreement which has been widely billed as their most comprehensive package to aid Greece. Now that the dust has settled somewhat, Open Europe has published a new flash analysis assessing the key components of the deal.

For all the talk and all the figures flying around there is still only one that really matters – 124% debt to GDP ratio in 2020, clearly this is not sustainable. Further measures will be needed and the ad hoc nature of this deal, particularly the way it skirts the big decisions, suggests that fears over a ‘Grexit’ will return as soon as Greece begins missing its targets once again.

Although reaching some deal was better than nothing, there are still significant doubts over the deal. The mixture of measures do provide some short term relief but in most cases fail to solve any of Greece's real solvency problems. The policy with the most unanswered questions is probably the most important one - the debt buy back.  A key question is: who actually owns Greek debt now? Below we break down the shares of Greek debt (click to enlarge):

We expect that the only bonds actually eligible for the buyback would be those held by foreign financial institutions (€30bn). However many of these bondholders may be reluctant to take part for a multitude of reasons.

See here for the full analysis.

Trying to find two more years for Greece

Ahead of today’s meeting of eurozone finance ministers we thought we’d (finally) get round to posting some of our thoughts on the last week’s leaked Troika report on Greece. The report, as may be expected, left much to be desired – and we’re not just talking about the copious glaring gaps where the eurozone and the IMF could not agree (the missing new debt sustainability analysis being the more prominent). The firefighters are fighting amongst themselves as one paper put it.

The report suggests that the cost of providing Greece with a two year bailout extension will be €32.6bn – very much in line with our estimates of between €28.5bn and €39bn. Interestingly, up to €20.3bn of this total is due broader problems with the original bailout programme, with the troika suggesting only €12.4bn will specifically be for the fiscal adjustment. This may not seem like it matters much but it highlights that the financing issues don’t just come from fiscal issues but also low growth, increasing arrears, banking sector problems and more.

Below we list a few other concerns from the report:

- The unemployment figures, as in the recent Greek budget, seem to be hopeless optimistic – potentially more so than before, since the Troika see unemployment in 2014-2016 being 0.4% below where the Greek government does. Elstat (Greek Statistics Agency) put unemployment at 25.4% at the end of August, while the Troika expects it to be 22.4% by the end of the year. A 3% drop in unemployment in a few months? That seems impossible anywhere but particularly in the current Greek economy.

- The report expresses some deep concerns over the banking sector not least the “plummeting” deposits and the likely need to run down capital buffers due to significant levels of bad loans. However, it still concludes current levels of recapitalisation should be sufficient – we’re sceptical.

- Despite, finally cutting defence spending, Greece still spends the third most (as % of GDP) in the EU. This continues to seem an obvious place to make savings, particular with NATO still going strong.

- The collapse in real investment of 40% since 2009 is staggering if not surprising, yet the forecasts for investment both in the troika and budget reports only looks ever more optimistic because of it.

- Government arrears continue to mount up, topping €8bn now. Despite presenting a significant challenge to wind down in the near future, these could also represent a drag on the domestic economy since most of the money is owned to domestic firms. 

That is to name but a few from an incomplete report – i.e. there are plenty more to come.

As for the outcome of today’s meeting, we have low expectations as usual. The target is for a political agreement on the releasing the next two tranches of Greek funds (worth €44bn). This doesn’t sound much of a stretch but it will require confirming Greece has completed the necessary ‘prior actions’, as it claims, while the IMF is hesitant to release any more funds until it has settled on a plan which sticks to its view of Greek debt sustainability. The final part will be tricky with the IMF and the eurozone still seemingly someway apart on what they see as sustainable (despite the two of them also being someway apart from the rest of the economic and financial professions).

A deal on how to fund the two year extension in the Greek bailout will likely need another meeting, while the release of funds still has to withstand the hazardous approval process of the German, Dutch and Finnish parliaments.

Expect the debate over the issues above and more to dominate for another few weeks.

EU awarded its second Nobel Prize of the year

Yesterday, a delegation headed by Bernadette Ségol, Secretary General of the European Trade Union Confederation (ETUC), delivered a 'Nobel Prize for Austerity' to the EU - a boomerang with 'Austerity will come back in your face' written on it, according to Italian news agency ANSA.

Unsurprisingly, Barroso, Van Rompuy and Schulz weren't exactly elbowing their way to the front of the queue to pick up the award, which was ultimately handed to EU Social Affairs Commissioner László Andor.

This was the only (relatively) light-hearted moment of a day which saw anti-austerity protests degenerate into violent clashes between demonstrators and the police in Italy, Spain and Portugal - while marches were also staged in several other European countries. Some Spaniards even rallied in Smith Square, London, in front of the European Commission and European Parliament's offices (see the picture, which was posted on Twitter yesterday evening).

We have stressed on several occasions that these protests are the inevitable consequence of the clash between eurozone membership and national democracy.

While structural reforms and fiscal consolidation are needed for struggling eurozone countries to try to regain competitiveness within the single currency, what the European Commission should be most concerned about is the fact that citizens in the weaker eurozone countries increasingly see the EU (and certain creditor member states) as the cause of their pain.

As we noted in a recent briefing, the average level of trust in the EU in Greece, Spain, Portugal, Ireland and Italy has reached an all-time low. Again, it is impossible to know where the tipping point lies exactly - but the recent episodes seem to confirm that the number of those who see the EU as a positive force is rapidly decreasing.        

Economic realities push Europe closer to a Greek decision

We have a piece in City AM today, which look's  at the impact of this week's crucial votes in Greece, see below for the piece in full:

One down, one to go. The Greek government has got through one crucial vote this week and looks likely to ride out the budget vote on Sunday. Although markets and eurozone leaders will breathe a sigh of relief as Greece makes it through another crucial week in its economic crisis, the government has not been left unscathed.

Pushing through the latest, and supposedly last, package of stringent economic reforms and budget cuts has exposed deep cracks within the governing coalition, as the Democratic Left and Pasok parties put up a fight to slow the process of public sector cuts led by Prime Minister Antonis Samaras’ New Democracy party. It took two days to push the package through parliament, while a reported 100,000 Greeks took to the streets in Athens to protest against austerity, once more leading to violent clashes with police.

However, a bigger problem for the government is the flurry of economic figures which have again exposed deeper flaws in the Greek economy, propelling talk of a Greek exit from the eurozone back into the headlines. The new budget projects Greek debt peaking at 192% of GDP, rather than the 167% estimated previously, but even this revision seems to be built on optimistic assumptions. Unemployment, investment and exports are all projected to stabilise, despite most indicators predicting the opposite. In fact it is now abundantly clear that Greece will need an extension to its current bailout.

The questions to ask then are: how much would such an extension cost and how could it be funded? We estimate that slowing the Greek fiscal consolidation programme by two years could cost an extra €28.5bn (rising to €39bn if Greece fails to borrow from the markets – something which looks increasingly likely). The main options being proposed include: reducing the interest rates which Greece pays on its current bailout loans (which could raise around €3bn over two years) or putting a hold on interest payments for a few years (which could raise €10bn+, but would be much trickier legally). These options would likely be combined with some further austerity and increased short term debt issuance by Greece – both of which could actually increase Greek debt levels, not exactly what is needed. The kicker is that even this is unlikely to be enough.

The question of an extension then, drives home that a larger decision on Greece’s position in the eurozone is closing in on EU leaders. Even talk of using bailout loans to buy back Greek debt at a discount and then retire it, to provide extra funding, would require a big political decision on further loans to Greece. However the funding is found, it will likely involve breaking a taboo – either by the ECB (in terms of helping to fund states) or more likely by eurozone countries in allowing permanent transfers to a country whose future funding is far from assured.

The Greek government and the eurozone will make it through this week but this short-term success is likely to belie the massive decisions ahead.

A big week for Greece - but still few answers

As we noted in our press summary today, this week is lining up to be another big one for Greece.

The Greek government faces two crucial votes in parliament – first on Wednesday to push through the latest package of structural reforms (as demanded by the EU/IMF/ECB) troika and second on Sunday to approve the latest and, according to Greek PM Antonis Samaras, the last austerity budget for next year.

Since the governing coalition was formed after the second summer elections, such votes have usually passed without much fanfare. However, this time around the Democratic Left (which holds 16 seats in parliament) has said it will not vote with the its coalition partners. Pasok (which holds 31 seats) is also facing a period of internal strife with one MP already leaving and up to five others threatening to at least vote against the government. New Democracy (127 seats) should have an easier job pulling its MPs together.

The votes should pass but the margin for error is tiny, possibly only two or three votes, notably provoking unrest amongst financial markets and other eurozone leaders. In the end, given that the end of the government would very possibly signal the end of Greece as eurozone member, the (perceived) fear factor is likely to be enough to once again push the vote through.

This clears the way for the release of the next €31.5bn tranche of bailout funds and a potential two year extension to the Greek bailout. Today’s FT notes that the extra funding for the extension is likely to come from an increase in short term debt issuance by Greece and possibly a reduction in interest rates on eurozone loans to Greece – exactly as Open Europe predicted in its recent flash analysis on the issue.

The FT article also includes a potential plan for the ECB to return profits from its purchases of Greek bonds to Greece via eurozone governments to avoid the thorny issue of the central bank directly financing a state. This sounds plausible on the surface since the returning of profits to national governments should happen naturally anyway under the ECB rules. The only issue being that this can only happen overtime as the profits accrue as the bonds are paid off, so its unlikely to be paid out in a single chunk at one time (as is needed here).

One final point on the cost of the extension. We put it at around €28.5bn, although estimates range from €15bn to €40bn. We didn’t include a delay in Greece’s return to borrowing from the markets, which is looking increasingly likely. If Greece doesn’t return to borrowing until after 2016 it could add a further €10.6bn to the cost of an extension.

So although this is a big week for Greece, even a clear government win in both votes will do little to answer questions over Greece’s future in the eurozone.

Another disastrous budget for Greece

This week saw the release of the Greek budget plan for 2013-2016 and it did not make for happy reading. The English version is yet to be released but below we reproduce some of the key facts and figures from the Greek report. The table below essentially sums up the report and the crushing blow it delivers to hopes of a Greek recovery:

Debt peaking at a 192% of GDP in 2014! Astonishing given that less than six months ago the EU/IMF/ECB Troika seemed supremely confident that Greek GDP could stabilise at 120% of GDP by 2020 and would peak in 2013 at only 167% of GDP. (It’s also worth checking out this FT Alphaville post which highlights just how wrong some of the previous estimates were).

It’s easy to say that Greece failed to fully implement reforms and adhere to the bailout conditions (which it did) but at some point the failure of policies themselves and the fudging of the numbers must be admitted.

To many of us all of this was already abundantly clear but the release of the official figures confirming it at least ensures that the political debate will need to be moved on – expect ‘Grexit’ discussions to return to the headlines with a vengeance.

There are also a few interesting nuggets in the budget which suggest to us that further revisions may be likely:

• Firstly, unemployment is expected to go from 22.4% this year to 22.8% next year and then decline to 17.1% in 2016. It’s hard to see how this can happen with both government and private spending expected to fall over this period, while there will also be plenty of labour market reforms which tend to increase unemployment, at least in the short term. 
• Despite dropping by 15% this year, investments are expected to fall by only 3.7% next year and then return to growth. Again this seems massively optimistic without a permanent fiscal transfer supporting Greece and remove the cloud of a Grexit which continues to deter investors. 
• Exports are expected to grow at an increasing rate over the next five years, despite the eurozone and the global economy potentially posting low levels of growth. 
• Private consumption is expected to fall by 7% next year (after 7.7% this year), and yet this is expected to be consistent with a 4.5% contraction in GDP rather than a 6.5% one seen this year. Combined with falling government spending and structural reform this is again hard to imagine. 
• Table 2.5 highlights what could happen if Greece does not implement its medium term fiscal strategy (aka. its austerity packages and structural reforms), putting debt at 220% of GDP in 2016. This highlights how easily the levels could once again veer off track if many of these unrealistic targets are not met. 

As we mentioned in our recent note, a two year extension will be far from enough for Greece and this budget further reinforces that fact. With it now out in the open, discussions over the next few weeks should focus on more than just Greece’s next two years, but the fundamental decision of whether Greece belongs in the euro.

Revising the Greek bailout: Two more years of extend and pretend?

Open Europe published a new flash analysis on Friday, which looks at the prospects of a revision to the Greek bailout. It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

The €28.5bn comes from: an extra €14bn due to slower deficit reduction, an extra €12bn from reducded privatisation receipts and an further €2.5bn from increased government arrears (unpaid bills).

We examine six key options for filling this gap:

1. A reduction in interest rates - which looks very likely but could only deliver €2bn - €3bn.

2. Increased short term debt issuance and more austerity - this looks possible and could deliver anywhere between €15bn - €20bn.

3. Extending length of loans to Greece - unlikely, it could raise €9.1bn in the short term, but on net it would give zero reduction.

4. ECB forgoing interest and/or profit on its Greek bonds - looks very unlikely, but could yield €1.15bn - €2.3bn (interest rate cut) and/or €14.25bn (forgoing profit).

5. Bond buybacks - again very unlikely, but it would mark a much larger step than simply covering the funding gap, as it could deliver €45.65bn overall and €17.15bn after the two year extension is paid for.

6. Write-down original eurozone bilateral loans -  this would be a huge step and could provide €26bn to €52bn but looks very unlikely to be approved, especially as it would support in national parliaments. 

Overall then, its hard to see how the gap will be filled without some larger decision being taken over the future of Greece in the eurozone. To read the full note, click here.

EU and the Nobel peace prize: the once-celebrated actor who just got a life-time achievement award?

It’s common practice in Hollywood to give a life-time achievement award to a once-celebrated actor whose career is in decline. Although he or she hasn't really done a good movie in years, the award acts like a bit of encouragement and/or belated recognition. The exercise is partly driven by appreciation but also has a condescending feel to it, with the implicit suggestion being that your best days are behind you.

When we heard the unexpected news today that the EU won the 2012 Nobel Peace prize, we couldn't help but to draw this analogy. You can almost picture the actor (the 'EU' in this case) – dragging themselves up onto the stage to collect their award despite having since gone through several broken marriages, a series of stays in rehab, and a ton of plastic surgery. It’s all for show – but we can’t help but feel it’s a bit sad at the same time.

As ever with the Nobel Peace Prize, this year’s decision will divide opinion – to put it mildly. British eurosceptics’ blood pressure has already been raised several notches. And equally we don’t want to ruin the orgy of self-congratulation currently underway in Brussels. While Europe’s epic moments have belonged to national politicians and not to Eurocrats, these guys haven’t had something to celebrate since the Irish were forced to vote ‘Yes’ in the second Lisbon referendum; they (sort of) need a bit of a break.

But what’s clear is the EU isn't exactly hot at the moment. Trust in the EU in the Mediterranean – the countries to which the zone of peace and stability spread in the 1980s and who have traditionally been the strongest supporters of the project - has dropped from 55% to 25% in a decade, in the wake of euro-induced pain. Several countries are in recession. Angela Merkel got a pretty rough reaction in Greece earlier this week. Far from uniting countries and fostering “solidarity”, the Eurozone crisis risks driving a wedge at the heart of the European project, between north and south in particular.

But at the same time, to be fair, despite Angela Merkel trying to bundle the two together (a mistake), the EU isn't only the euro. The Nobel committee is right that 'the EU' as a trading block has contributed to stability and peace in Europe, first following WWII and then carrying on throughout the transition of Mediterranean ex-dictatorships and post-Communist countries. The idea of stability through trade is fundamentally a good one, and enlargement is the EU’s only proper foreign policy tool. But the awarding committee, of course, hugely simplifies the issue. The EU is only one of several factors which played in maintaining peace and stability in Europe after WWII; the role of NATO cannot be overlooked in this context.

The saddest (some would describe it as the most ironic) part about the EU’s lifetime achievement award is that through ideological over-reach, political vanity and economically illiteracy, i.e. the Eurozone at 17, much of what Europe has collectively achieved with respect to trade, peace and stability, risks being undermined. The committee should have added this lesson to its motivation: trying to stamp out economic and democratic realities through political and ideological ambition alone never ends well.

PS: Organisations have of course won the prize before – the UN, the inter-governmental panel on climate change, Amnesty international etc – but the debate is currently raging as to who, exactly, will accept the prize. This links to a second question. Who, exactly, did the Norwegians award the Nobel Peace Prize to? Jose Manuel Barroso? Herman Van Rompuy? Angela Merkel – whose taxpayers are currently paying for the party? The European Parliament - many of whose MEPs are under the impression that they are seen as the legitimate democratic voice for European citizens? The head of that fine entity known as the European Social and Economic Affairs Committee (if you've never heard of it, not to worry)? Or the millions of Europeans who travel and trade across borders rather than shooting at each other (and vote for politicians who want them to do just that)? Who, exactly?

If the latter, the Open Europe team is honoured to have received the Nobel Peace Prize – and the roughly €0.0027 each that the prize money comes to. (Nobel prize award of €1,354,045 ÷ 502,489,143 inhabitants = per citizen via @RuadhanIT).

Is the crisis starting to get to Juncker?

Asked by a journalist earlier this afternoon what the significance the upcoming Troika report would have for the further Greek rescue effort, eurogroup head and Luxembourg Prime Minister Jean-Claude Junker replied that:

"If the donkey were a cat it could climb trees and spend the whole day in the treetops"

Answers on a postcard.

The 'forgotten man' of the euro crisis catches a break...

While everyone is gearing up for the EU's 'Super Wednesday', Portuguese Finance Minister Vítor Gaspar has made a quite important announcement. As we anticipated in our daily press summary more than two weeks ago, following its fifth monitoring mission to Lisbon, the EU-IMF-ECB Troika has decided to give Portugal one extra year to make the budget cuts agreed under its bailout programme.

The 'forgotten man' of the euro crisis will therefore be allowed to close the year with a deficit of 5% of GDP (instead of the previously agreed 4.5%). Portugal will then have to cut its deficit down to 4.5% of GDP (instead of 3%) next year and to 2.5% of GDP in 2014. No doubt the one off transfers from pension funds to push the deficit below previous targets finally caught up with them. 

The news is particularly interesting - and not only because Portugal seems to have fairly easily achieved what Greece has failed to obtain so far, despite Greek Prime Minister Antonis Samaras's recent 'diplomatic offensive'. In fact, Portugal is still expected to return to the markets in September 2013 (exactly one year from now). Given that the country has been allowed to run a larger deficit for this and next year, this suggests that it will have to borrow more money to cover for it.

For the moment, Gaspar has made clear that nothing has changed on that front, and Portugal will try to raise the money from private lenders (i.e. will not ask the EU and the IMF for more cash).

However, this brings us on to another interesting fallout from the ECB's new Outright Monetary Transactions (OMTs). Since currently bailed out countries, such as Portugal, can access support from the ECB when they are due to return to the markets, there is a good chance that the ECB could buy up some existing Portuguese debt from the secondary markets in September 2013, allowing banks to reinvest this money in the  new debt Portugal will issue. This also allows Portugal (and the eurozone) to sidestep the IMF's demand that countries be able to show clear funding streams for 12 months (which led to the second Greek bailout request).

So, despite delaying its deficit target and not being guaranteed market access within twelve months, Portugal looks able to avoid a second bailout with the help of the ECB (at least for the moment). One should now only ask whether the conditions attached to the Portuguese bailout programme will satisfy the ECB, especially after they have been eased...

The best use of Greek politicians' time and effort?

As we reported in today’s daily press summary, the Greek government has set up a ‘working group’ to scour historical archives and tally how much Germany could owe the country in outstanding reparations from World War II. Deputy Finance Minister Christos Staikouras is quoted in Kathimerini as saying that:

"The matter remains pending… Greece has never resigned its rights." 

This is obviously quite complicated historical stuff. But given the state Greece is in, it is worth asking whether pursuing this course of action is the best use of Greek ministers’ and officials’ time and effort.