On June 27th Greece broke off negotiations with the Troika (IMF, European Commission, and the ECB), when Greece determined that the terms of a debt restructuring agreement with the Troika was untenable. Greece also announced that they would hold a referendum for voters on July 5th to determine if the terms offered by the Troika would be accepted. The Troika seemed surprised by Greece’s departure, but it was hardly a surprise given that the terms mandated by the Troika would leave Greece in “debtor’s prison” and with something less than real sovereignty. Greece (and just about everyone) understands that their current level of debt and debt service is unsustainable and must be reduced if there is any chance of changing the ultimate outcome of Greece’s financial circumstances.
Greece’s decision to leave the negotiations, just two days before the due date of a payment of 1.6 billion euros to the IMF, prompted the ECB council to suspend further access to ELA (Emergency Liquidity Assistance), which has been keeping Greek banks solvent as worried customers withdrew bank deposits. In turn, Greece was forced to close the banks and implement capital controls that limit customer ATM withdrawals to just 60 euros per day. It was initially announced that the banks would be closed until July 6th, the day following the referendum. (It was subsequently determined that certain banks may open sooner for withdrawals by pensioners only.)
The complex wording of the July 5th referendum, leaves the vote subject to “positioning” by the Greek Government that a “no” vote gives Greece more leverage to gain an improved agreement with the Troika, while the Troika offers rhetoric that a “no” vote means Greece is voting to leave the euro. The fact is there is no protocol for either voluntarily leaving or being forced from the EU, so the Troika’s argument really doesn’t hold water. On the other hand, Troika officials are growing tired of the tactics of the Greek government and may not be in the mood to offer a better deal. However, it now appears that the both sides may be softening in an attempt to find a short-term solution.
As noted above, the issue at hand is Greece’s overwhelming amount of debt relative to the size of its economy and a repayment schedule that cannot be met without the Troika extending additional credit to Greece just to make the payments. In addition to the 1.6 billion euros owed today, Greece has a 3.9 billion euro payment due on July 20th. It is clear that absent additional credit being extended, Greece will not make these payments. Non-payment does not classify as a default from the perspective of credit rating on commercial debts. While this would typically be referred to as a “payment in arrears,” IMF Managing Director Christine Lagarde has said there would be no grace period on the June 30 payment and the IMF would declare a “partial default.” A default triggers a number of other issues, but as the saying goes, “you can’t get blood from a stone.”
The total amount of Greek debt currently outstanding is 243 billion euros, with Germany by far the largest creditor. This figure includes loans of 220 billion euros made in two bailouts from European governments and the IMF since 2010, as well as Greek government bonds that were bought by the European Central Bank. Private investors hold about 39 billion euros of Greek government bonds, the value of which were considerably higher before being written down in 2012. What stands between an agreement between Greece and the Troika is Greece’s insistence that their debt be written down to an amount that is manageable and sustainable over the long term, while the Troika wants further commitment (read austerity) from Greece before further reducing Greece’s debt.
Of course, the Troika is also concerned with the moral hazard of just “writing down” Greece’s debt balance as well as the possibility of contagion throughout the rest of the EU. Greek debt is now far more concentrated in stronger hands than it once was, so the risk of contagion has been greatly diminished since 2012. As such, the EU believes it is in much better shape to prevent any wide and deep contagion. Furthermore, the Troika believes that if contagion occurs they have tools (quantitative easing) to mitigate the situation. As of now, it appears that the EU is more afraid of excess compromise than contagion. However, this story is not over. It should be noted that anything other than a meaningful write down of Greek debt will likely result in the whole ugly issue being revisited in the years, if not months, ahead.
If an agreement is not reached and a “Grexit” happens it will likely occur over an extended time, probably after a long negotiating process with the Troika. Because there is no existing protocol for withdrawal or expulsion from the Euro, all parties would be operating on new ground. Most probably parallel currencies would likely be used, while the Greek banking system is restructured. It is very hard to predict what will happen next considering the myriad of variables. However, most believe that the fallout of a Grexit can be controlled after the immediate reaction from world markets. Control is a relative thing, so caution is the watchword.
We are keeping a close eye on this situation and how it may impact our portfolios. In the meantime, please feel free to reach out with any questions or concerns.
Chief Investment Officer
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