26th March 2010 by Shaun Richards
Over the past couple of months those of us following the Greek saga have got somewhat used to European politicians declaring that there is a rescue plan for Greece. The words of Yogi Berra an American baseball coach “it is just like deja vu all over again” have echoed in my ears several times. This new plan whilst not perfect does at least have some substance to it and I shall analyse it today. In addition there has been a technical move by the European Central Bank which will help Greece after the end of this year. So there is a strong feeling this morning that the Euro zone is beginning to get its act together.
The Rescue Plan
Criteria for help: Greece is in “very serious difficulties”
Method of help: 1/3 rd is loans from the International Monetary Fund and 2/3 rds will be coordinated bilateral loans from other Euro zone countries.
Size of help: 22 billion Euros
How will Europe contribute? In relation to its percentage shareholding in the European Central Bank. I suspected this would be the formula and calculated the percentages for my article on Monday which I repeat below.
If you go down the shares of ECB membership as published on its website you get
Germany 27.12% France 20.37% Italy 17.9% Spain 11.89% Netherlands 5.72% Belgium 3.48%, the rest are relatively small contributors.
This plan to be activated requires assent from all Euro zone members ( a victory for Germany as this is another form says that Germany has a veto!). Also there was an interesting phrase added to the agreement saying that European Union members should commit to closer “economic governance” for the future. According to the FT the phrase was changed slightly at Gordon Brown’s request. If politicians had put the same effort into arranging a deal as they do into wording communiques this situation would have been sorted ages ago.
My first view is this plan is flawed but it is also a step forward, mainly because there appears to be a plan this time! The initial flaw is the phrase “very serious difficulties” as a criteria which is rather opaque. Once a day or two has passed and relief gives way to thought and analysis market players and observers will start to wonder exactly what this phrase means. So an improvement would be to set actual criteria. There are other consequences of this iterative compromise between Paris and Berlin.
There is an emasculation of the IMF’s usual role in this rescue plan. Two clear policy weapons that the IMF usually deploys are not available to it these are.
1. Exchange rate depreciation or devaluation
2. Changes in interest rates
This only really leaves fiscal policy as a tool,so the Greeks will be forced to use this weapon to maximum effect as far as I can see. So whilst they may well be permitted a sigh of relief this morning there is no end in sight to the fiscal squeeze required of them ( which for example is far tougher and harder that the one proposed by Chancellor Darling in the UK Budget on Wednesday). This is something which is unusual rather than unprecedented but having only one policy tool has implications. Those in Greece may want to look away from the rest of this sentence but Latvia was in a not dissimilar situation and for what happened to her I refer you to my update of the 12th March.
The Euro zone
The credibility of the Euro zone has been affected by two main things. The first is the failure of Europe’s politicians to anticipate that there would not only be sunny days for the Euro,so it was left with no emergency criteria or provisions. It remains to be seen if that turns out to be a fatal flaw. The second is that the dithering and grandstanding of the current generation of European politicians has helped turn a drama into a crisis.
Finally after a lot of horse-trading between France and Germany we have a plan but as I have indicated earlier it too has a flaw which may prove fatal. Lack of clear criteria for action. Germany plainly sees this as a last resort plan, but Mrs Merkel cannot credibly go back to Germany and claim no money has been provided for Greece and yet claim there is a deal. Markets tend to test such fudges sooner or later.
Such criteria as there is will be set by the European Commission and the European Central Bank (ECB) who will decide when ““market financing is insufficient” for Greece. If you wished to set up an unwieldy trigger for action then this is exactly the way to do it. If you were at the ECB and feeling a loss of sovereignty and power you might be tempted not to give this plan your full efforts might you not? In fact this makes me wonder if Germany feels that this is so unwieldy she may never have to contemplate action, if so on my logic of markets testing fudges sooner or later she may be in for a surprise. The price for this surprise will initially be paid by Greece.
The cost of the bilateral loans will reflect “risk adequate pricing” with an indication that rates will be high. Again my thought is what does that mean in practice? For if there is no subsidy element as claimed it poses the question why should Greece take it? I suspect in practice we would see more Euro fudge. Consider the phrase ““to set incentives to return to market financing as soon as possible”. You see for this plan to be triggered rates would presumably be sky-high so there is another flaw in the plan.
The ECB and Collateral
This is a much more important issue than it may seem. Being able to give collateral to the ECB in return for loans is rather valuable when its interest rates are so low (1%). To look at Greece there have been estimates that last year her banks made profits of 3/4 billion Euros from this route. However the downgrades which Greece has suffered from looked like it was going to mean that when the ECB returned from an emergency to a more normal setting at the end of 2010 then Greek government bonds would not qualify as collateral. Ouch if you are a Greek banker (their share prices reflected this amongst other things)!
However this has now changed and the ECB is now plan to retain her emergency setting into 2011. This is quite a reverse as let me enlighten you ( and thank you to the FT for these gems)
9th February 2010 ECB President Trichet, stated that the ECB will not change its collateral framework for any country: “no government, no state can expect special treatment”. and
23 rd February 2010 ECB member Gonzalez-Paramo commented on the ECB’s collateral rules in an interview saying “It’s certainly unthinkable to change the rules to solve the specific problems of any individual country or bank”.
So whilst the change is sensible it is also embarrassing for the two above. Perhaps in an attempt to cover their embarrassment there is also talk of haircuts for lower rated collateral.
As talk of a deal circulated yesterday afternoon Greek ten-year bond yields remained at 6.30% which is twice Germany’s, perhaps some ennui was evident here. The Euro rallied but it is down more than 6% this year against the dollar.
Portugal was downgraded by a ratings agency earlier this week but her ten-year bond yields and spread over Germany has been barely affected, if anything it has marginally improved at 4.38% and +1.21% respectively. Maybe there is a glimmer of hope here in that the ratings agencies are being downgraded themselves, not before time many would say!
There has been a large loss of credibility for the Euro zone through this crisis and many of its institutions have been damaged. This is illustrated in one day by two quotes from the President of the ECB Mr. Trichet. Firstly IMF involvement would be ““very, very bad.” and later in the day a plan involving the IMF is something which leads him to be “extraordinarily happy that the governments of the euro area found out a workable solution.”
On a deeper note and I will choose my words carefully here there has been a big change. Germany which has been considered to be somewhat expansionary in the past is now looking rather inward and insular. Should this rescue plan ever be activated imagine the chaos if it was sent to her Constitutional Court.
Update 1.45pm: UK Implication
As a shareholder in the IMF then we will have a role in the financing of part of this plan. In case you were wondering we are a 4.51% shareholder in the IMF .Gordon Brown has issued a statement denying “direct” involvement in the rescue and this is why he uses the word direct. By my maths if the plan turns out to be 22 billion Euro’s the UK’s implied share in IMF lending is around 330 million Euros.
In case you wondered how IMF bureacrats keep themselves occupied the formula for calculating shares is CQS = (0.5*Y + 0.3*O + 0.15*V + 0.05*R ) k