Flashnote

Economics
Europe

Greece crisis
The top ten questions
Fears over a possible Greek exit from the eurozone are
growing...
as relations between the creditors and Greek negotiators
over reforms grow increasingly tense
We address the key questions surrounding ECB emergency
financing, capital controls, default and Grexit
1. Will the ECB raise the ELA limit on Wednesday 17 June?
The governing council will meet on 17 June to review the amount of emergency liquidity
assistance (ELA) that will be provided to the Greek banks (currently EUR83bn) and
potentially the haircuts it imposes on the Greek collateral. While it is possible that the
ECB could refuse to raise the limit this week in an attempt to put pressure on the Greek
government to compromise at Thursdays meeting of the Eurogroup (Eurozone finance
ministers), we would be surprised if this happened. We therefore expect that the limit will
be raised by EUR1-2bn. Note that in the case of Cyprus in March 2013, the ECB did not
cut off ELA to banks, but threatened to do so if Cyprus did not enter into a new
programme with the Troika.

2. Is the Eurogroup on Thursday 18 June a hard deadline?

16 June 2015
Janet Henry
Economist
HSBC Bank plc
+44 20 7991 6711
[email protected]
View HSBC Global Research at:
http://www.research.hsbc.com

Issuer of report: HSBC Bank plc

Disclaimer &
Disclosures
This report must be read
with the disclosures and
the analyst certifications in
the Disclosure appendix,
and with the Disclaimer,
which forms part of it

Eurogroup head, Jeroen Dijsselbloem, previously identified the Eurogroup meeting on 18

June as the deadline for reaching an agreement. This was presumably on the basis that a
couple of weeks would be needed for those countries (e.g. Germany) which have to pass
the agreement through parliaments to do so, and for the Greek parliament to pass the
required laws through its parliament. Only then would they be able to unlock at least part
of the EUR7.2bn of funds which have been on hold since December and allow Greece to
meet the EUR1.55bn payment to the IMF at the end of June. Note that there is currently
little or no prospect of a full third programme, involving additional funds being agreed
imminently: negotiations currently relate to some kind of interim deal which would cover
Greece over the summer. The immediate priorities are to enable the government to make
the EUR1.55bn payment to the IMF at the end of June and the EUR7.7bn (EUR3.5bn in
July and EUR4.2bn in August) to the ECB but, as we showed in Greece: not much time
left, 12 June, an extension of the EU programme until September 2015 would require,
according to our estimates, at least EUR11.6bn.

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16 June 2015

3. How far apart are both sides?

No formal proposals have formally been made public but various documents (reportedly from the EU
creditors and the Greek government) have been posted online and quoted in the press. To spare readers
the pain of reading all of the documents and all of the headlines from various policymakers, politicians
and institutions we have summarised the key areas of difference as we see them, bearing in mind of
course that it is never entirely clear which are definitive red lines and which are negotiating tactics.
In summary, they seem to have reached a compromise on the primary surpluses for 2015-2016 and are
close to a deal on VAT reform, though the Greek government is still resisting any changes that will raise
the price of basic goods and services. The Greek governments resistance to wage and pension cuts (in
particular the phasing out of the non-pension solidarity grant (EKAS) paid to pensioners on very low
pensions) is the main stumbling block and it is the main red line that the Greek prime minister, Alexis
Tsipras, is refusing to cross. Note that the gap in the budgetary proposals currently being put forward by
the creditors and the Greek government amounts to about EUR2bn in 2015 and EUR3.6bn in 2016.
Table 1: Greek government is determined to avoid wage and pension cuts
Creditors' "latest" demands

Greece's "latest" proposals

Primary surplus
target

Primary surplus target of 1%, 2%, 3% and 3.5% of GDP for

2015, 2016, 2017, 2018. IMF has indicated that any further
concession would require further debt relief for debt
sustainability.

Primary surplus target of 1% for 2015 and 2% for 2016. To

close gap, agreed to higher VAT revenue, rise in corporate
tax rate (from 26% to 29%), special 12% corporate tax,
defence cuts, pharmaceutical rebate cuts

VAT system

Target a net revenue gain of 1% of GDP on an annual basis.

Employ a standard rate of 23% (including on electricity) and
a reduced rate of 11% for food, medicines and hotels.
Broaden the base and eliminate exemptions e.g 30%
discount applied in many Greek islands

The current VAT rates of 6.5%, 13%, 23% to be changed to

6%, 13%, 23%. The 6% rate will cover: medicines, books,
theatres. The 13% rate to cover newspapers & magazines,
basic fresh food stuff, energy, water, hotels and restaurants.
The 23% rate will cover a broader range of goods and
services than currently

Labour market
reform

Instead of insisting on new policies, the Institutions propose - To reinstate collective bargaining procedures, under a plan
a "consultation process" on minimum wage, mass dismissals to be approved by the ILO
and collective bargaining policies
- Minimum wage levels and private sector salaries to rise
gradually until end-2016 to 2010 levels. Wages to be freely
negotiated thereafter through collective bargaining

Pension reform

Implement pension cuts worth 0.25-0.5% of GDP for 2015

and 1% of GDP for 2016. Measures such as removing
exemptions by significantly tightening early retirement rules,
increasing health contributions for pensioners, immediate
implementation of a balanced-budget rule for supplementary
pensions and progressive phasing out of the non-pension
solidarity grant (EKAS) by end-Dec 2016

Syriza is willing to pass legislation to discourage workers from

taking early retirement before the age of 62. But this is only
estimated to generate EUR71 m, or 0.04% of GDP. The
government is strongly opposed to the balanced budget in
supplementary pension funds and the abolition of EKAS or any
other measure that would lead to a cut in wages or pensions.
EKAS is a top-up payment for people on very low pensions

Source: Kathimerini, press reports, HSBC

4. Is there an option which is face-saving for both sides?

Not an obvious one, though this has not stopped the IMFs chief economist, Olivier Blanchard, from
making suggestions after the breakdown of the weekend talks. He indicated that the European creditors
should lengthen Greeces debt maturities, lower its interest payments and soften their demands on
reforms while Greece should agree to some of the pension and VAT reforms. One of the difficulties of
course is that the creditors (EU and IMF) themselves have some differences of opinion: Europe remains
concerned about the moral hazard risk of giving Greece more debt relief, especially without improved
reform efforts. Hence, Europe will not want to agree any further maturity extensions and interest payment

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holidays before a third programme is in place, and so will be hoping that the IMF will agree to stay on
board in exchange for a commitment from the EU to do so in the future.
Meanwhile, as mentioned above, in Greece, protecting public sector pay and pensions is the crucial red
line of the Syriza-led government. But it will be virtually impossible to close the gap without some
concessions on pensions. Public spending on pensions accounts for more than 16% of GDP in Greece
which is the highest in the EU. The creditors are insisting that this is lowered by 1% of GDP and needs to
persuade the Greek government that this can be achieved while protecting the poorest pensioners.

5. What if no compromise is reached at the Eurogroup on 18 June?

If a deal is not reached by Thursday, the likelihood of missing the IMF payment rises, but even that
would not immediately trigger a default. Much will depend on the market reaction to the lack of a deal. If
the meeting ends without an agreement but with a conciliatory tone, ie an acknowledgement that they
have found some common ground and are working towards finalising an agreement at the EU council
(Heads of State) meeting on 25-26 June, the situation could calm. If, however, the meeting ends on a
similar tone to the negotiations at the end of last week with creditors claiming that Greeces proposals are
not credible and Greece claiming that the creditors just want to humiliate them, then the market reaction
would be much more negative.
Note that there is speculation in the press (Financial Times) that there could be an emergency summit of
leaders on Sunday 21 to try to find a solution. Given the technical details that still need to be hammered
out, it currently seems unlikely that the leaders will quickly agree over a weekend, but it is a possibility if
there is serious market pressure on Friday. Such emergency summits to find a solution before markets
opened on Monday morning were commonplace during the worst points of the sovereign crisis.

6. Would capital controls have to be imposed?

Reports in the European press (Sueddeutsche Zeitung) are discussing the possibility that capital controls
could be imposed as soon as this weekend, if Thursdays Eurogroup meeting fails to reach a compromise.
This is certainly possible should a pick-up in deposit outflows accelerate to such a rate that any buffer
which remains in the ELA provision quickly evaporates. If they are implemented it would be reasonable
to assume that a weekend may not be long enough to implement them so a few days of bank holidays may
be required first. Note, however, that the imposition of capital controls would require the approval of the
EU, effectively putting Greece in the hands of its creditors.
Also note that while it is inevitable that comparisons are drawn with Cyprus the backdrop is quite
different. Cyprus was first and foremost a banking sector problem. Capital controls were imposed to
provide time for that problem to be addressed via haircuts on large deposit holders and a Troika
programme was put in place.
Greeces problems are primarily the public finances and the rigidity of the real economy. It is the
spillover effect which is causing problems for the banking sector. Imposing capital controls in Greece
with no imminent hope of a deal would undoubtedly be very negative for the real economy which has
already moved back into recession. Capital controls would include limits on ATM withdrawals (in the
case of Cyprus it was EUR300 per day) and on transfers overseas except where there is explicit

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16 June 2015

permission, for instance for legitimate business reasons which we assume would cover genuine foreign
trade transactions. Given Greece is quite a cash-based economy the impact on already-bad liquidity could
be very severe, depending on how long the controls are in place. Even in countries where capital controls
have been imposed to provide time to find an imminent solution to a specific problem, they stayed in
place for some time: two years in Cyprus and are still in place in Iceland seven years later though there
are plans to phase them out.
In terms of the details of any capital controls that could be imposed, it is impossible to assess the
implications for foreign investors at this stage as these would depend on the detail of the law passed by
the Greek government. In the case of Cyprus, the Ministry of Finance issued a Capital Controls Decree on
25 April 2013, which permitted the transfer of funds by international customers of credit institutions
which are a branch (or a more than 50% subsidiary of a foreign bank operating in Cyprus) unless the
transfer of funds involved domestic customers or domestic banks. Trade/business transactions were
restricted to EUR5,000 per day; payments of EUR5,000-200,000 were subject to the approval of a
Committee established within the Central Bank of Cyprus to deal with issues related to the controls. For
payments above EUR200,000 the committee took into account the liquidity buffer situation of the credit
institution.
Similarly, in Iceland foreign exchange transactions for commercial and service trading are the highest
priority. The Central Bank recommends that banks monitor larger transactions (no amount specified) and
evaluate the importance of each transaction. Priority products and services include groceries,
pharmaceutical products and oil products but transactions involving other imports and exports of goods
and services, travel, interest payments, contractual instalment payments and salaries are still permitted.

7. What if Greece defaults on the IMF at end June?

Missing the EUR1.55bn payment to the IMF would not trigger an immediate default it would take a
month for the delay to be notified to the IMF board. But it would hardly be considered a smart move.
No country has ever defaulted on the IMF and Greece will likely need further assistance from the IMF
whether or not it stays in the euro.
Note that S&P on 15 June issued a statement that non-payment of the EUR7.7bn of Greek bonds held by
the ECB which mature on 20 July and 20 August would not, per se, constitute a default under its criteria,
because the ECB is not considered a commercial creditor. We would expect it to take a similar approach
with regards to a missed payment to the IMF.
However, it is reasonable to assume that the market would not be swayed by the decision, or lack thereof,
of a ratings agency. It would immediately make its own decision and, in our view, it would be a very
negative one, although presumably if there is no successful conclusion at the June 25-26 European
Council meeting (or any subsequent emergency weekend summit) the negative market reactions would
likely precede the missed payment.

8. Does the ECB have to cut off ELA in the event of default to IMF?
The ECB would almost definitely have to lower the amount of ELA (via higher haircuts) but would
probably but not cut off the Greek banks. ECB head, Mario Draghi and board member, Benot Cur,

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have been very consistent in their responses to questions on this, saying that the ECB would continue to
extend liquidity to the Greek banks, as long as they are solvent and have sufficient collateral. But they
have given no definitive answer to the question as to how they would respond in the event of a default by
the Greek government. Mr Coeure stated that a default "would make it more difficult for banks to obtain
liquidity" while Mr Draghi said that the ECB assesses "how the developments in the markets affect the
quality of our collateral, namely the quality of the Greek government bonds that have been posted as
collateral. So were the conditions to changewe would have to revisit our previous decisions". We
interpret this to mean that the size of the haircuts on the Greek government bonds which the Greek banks
use as collateral for ELA would be larger in the event of a default so the amount of ELA they are eligible
for would shrink.
Note that Mr Draghi reminded us at the last press conference that it requires a two-thirds majority on the
governing council to change a decision on ELA.

9. Would default on the ECB on 20 July mean Grexit?

There have been numerous deadlines in recent weeks, and a few more in the next two weeks, but we
remain of the view that the key crunch point in the negotiations is the EUR3.5bn bond repayment due to
the ECB (plus EUR800m of interest payments) on July 20. We have consistently been of the view that a
last-minute deal will be reached and that Greece will stay within the euro. That is still our view. But if the
EUR3.5bn is not repaid to the ECB in the timely and fully paid way that Mr Draghi says has been
guaranteed by Greece, the likelihood of Grexit would increase dramatically.
Recent history has shown us that there is always scope for the rules to become more flexible: recall that
the there was a no bailout clause in the European Treaty but several bailouts have been delivered in
recent years. It is also notable that in April, ECB vice president, Vitor Constancio, said that even if
Greece defaulted on its debt there was no legislation that required it to be expelled from the euro.
So while default does not necessarily mean Grexit, default would certainly unleash new uncertainties and,
in our view, should the Greek government default on the central bank which is providing the liquidity to
keep the banking system afloat, this would be a potential game-changer. A default would leave the ECB
in the position of having undertaken monetary financing (debt monetisation) which it is legally prohibited
from doing. There would be possible ways around it. For instance the European creditors could decide to
make the outstanding disbursement (which it has been waiting to make to the Greek government once a
deal is reached) directly to the ECB but, again that would be a political decision by the European heads of
state should they decide there is still the political will to keep Greece within the euro.

10. Does high public support for the euro rule out Grexit?
A poll published on 11 June by MARC continues to suggest that the overwhelming majority of the Greek
population wants to stay in the euro including 70% of Syriza voters and 50% of those interviewed
think that the Greek government should, if there is no alternative, accept the conditions imposed by the
creditors, compared to 37% that would prefer a break-down of the talks with the risk of a possible default.
This has been confirmed by another, more recent poll conducted by GPO for a political show on Mega
TV (the biggest Greek TV channel) on June 15. In response to a very bluntly-worded question If the
choice for Greece is between either a bad deal with austerity measures while remaining in the euro OR

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16 June 2015

default followed by an exit from the euro? the response was that 56.2% preferred a bad deal with
austerity measures while remaining in the euro, 35.4% were in favour of default followed by an exit from
the euro and 8.4% didnt know/didnt answer. Other questions in the same survey showed even stronger
support: 68.5% said they would vote in favour of staying in the euro in a referendum. Therefore we
remain of the view that Mr Tsipras has a mandate to negotiate but a much stronger mandate to stay within
the euro and therefore to make the necessary concessions to do so.
But what if we are wrong and, irrespective of very strong opposition from within the domestic electorate,
the Greek government feels that it has been left with no option but to leave the euro? In our view Grexit
would inflict major damage on the monetary union and the rest of Europe, even though some are of the
view that the monetary union would be stronger for having rid itself of the bad apple and that Greeces
economy would revive on the back of currency devaluation.
While we accept that, in a world of QE and OMT (note the European Court of Justice finally ruled on its
legality on June 16) the initial market reaction may not be huge, there can be no doubt that a country
leaving the euro would change the fundamental nature of the Eurozone. The medium and long-term
implications could be very large indeed: economically, politically and geopolitically. It would be a
currency union where the risk of exit was greater than was previously the case. A union where any
country still battling with large budget deficits and high government debt would probably face a
permanently higher risk premium now that we would know that it is indeed possible for a member state to
leave the euro. At the first sign of bad news, be it signs of a budget deficit overshooting or a recovery
faltering, or anti-euro parties doing well in the polls, market pressure could quickly return. For
international investors could the euro really be such a reliable or stable source of value? And, if not,
would euro holdings decline?
For reasons of security it would not be in Europes interests to see Greece fall into the economic chaos
that we believe Grexit would represent (debt monetization, wage price spiral etc). In the EU treaties there
is no provision for leaving the euro (only the EU), which means it tends to be assumed that if Greece
leaves the Eurozone it would also have to leave the EU. But for geopolitical reasons we believe that, even
if we are proved wrong in our view that Greece stays within the euro, it would be in Europes interest to
keep Greece firmly in the EU and Nato, including providing it with further financial assistance.

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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Janet Henry

Important Disclosures
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This report is dated as at 16 June 2015.

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