Sunday, December 4, 2011

Greece's sovereign debt - perhaps the wrong party?

Those who are exclusively focused on the sovereign debt problem of Greece and possible solutions to it may soon find themselves at the wrong party. The explanation for that can be found in statistics from the Bank of Greece.

At mid-2011, Greece’s total foreign debt was 399 BN EUR and “only” 174 BN EUR of that was sovereign debt (i. e. direct debt of the government). The largest portion was in the financial sector (214 BN EUR) and the rest elsewhere. Just pay attention to the financial sector and you will quickly understand why this is a bomb waiting to explode.

What kind of debt is that 214 BN EUR? About 1/3 of it is more or less short-term trade financing and the bulk is general-purpose financial loans (some of which in the form of bonds).

There are probably a few foreign lenders to the Greek financial sector which consider themselves as “long-term relationship banks of Greece” and which will, therefore, stand by Greece in hell and high water. That means that they will continue to finance Greece’s trade and hold the financial loan facilities available.

Rest assured, however, that the majority of these foreign lenders are not relationship banks. They are banks who financed Greece when everyone else was doing it and now they get cold feet like everyone else. The classic behavior of such banks is to sell umbrellas while the sun is out and to race to the exit door as soon as the first raindrops appear.

Foreign lenders had begun racing for the exit door already in 2008 and that run really intensified after 2009. One can see that in the level of borrowing of the Greek financial sector from the ECB (the Bank of Greece’s borrowings from the ECB were 14 BN EUR in September 2008 and 107 BN EUR in September 2011). So, essentially, the ECB kept the Greek banking sector afloat since about 3 years ago.

That can’t go on forever! The ECB requires collateral for its lendings and they have already bent the rules as much as possible: originally, such collateral had to consist of top-rated sovereign bonds; then the ECB accepted the Greek sovereign bonds despite the fact that they were down-graded to near-default; and finally it accepted even collateral other than sovereign bonds. It is surprising that the Greek financial sector has so far been able to come up with the collateral required but sooner or later it will run out of eligible collateral (the new ECB-President has already hinted at that). What then?

What about foreign lenders other than the ECB? What happens when a Greek bank has a bond maturity coming up but lacks the funds? What happens when foreign lenders continue to cut short-term lines of credit for trade? Equally important: what happens if Greek depositors continue to withdraw funds at the rate they have been doing in the last 2 years?

And, finally, the million-Euro-question: who will finance Greece’s current account deficit going forward? Even if Greece stopped paying interest on her entire foreign debt (not only the government’s debt), the current account deficit will be 10-15 BN EUR for years to come. That money has to come from somewhere abroad or else Greece will not be able to pay for her imports.

It is quite amazing how the sages of the EU have reduced the issue of Greece’s problems to only the question of sovereign debt instead of looking at the country’s entire financing requirements. Yes, the ESFS is expected to include 30 BN EUR for the Greek banking sector but presumably these funds will be used to repay loans from the ECB because the ECB was never specifically authorized to make those loans in the first place.

Those who limit themselves to only the topic of Greece’s sovereign debt are not at the right party. The right party would and will be the question of how the country as a whole will be financed going forward and what kind of long-term economic plans must be made so that the country can obtain such financing (and thus maintain the standard or living).

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