The second wave of the Greek debt crisis seems to be focused on the technicalities of default. This time last year the EU authorities together with the ECB and the IMF were trying to find a stop-gap solution to Greek financial crisis, now the hard work begins as the EU authorities (in particular the ECB) try to wean the Greek financial system off temporary liquidity support.
To complicate matters, Greece isn’t playing ball. Its tax collection record is still dismal and its deficit cutting hasn’t happened fast enough to convince the EU authorities to give them more money. German officials have spoken out about Greece’s short falls and it was slapped on the wrist by the IMF last week. This pushed Athens to announce a wave of privatizations of state assets, but that wasn’t enough to stop Fitch, the credit rating agency, from cutting its long-term credit rating to B+. Fitch justified its actions by saying that the risk of default had dramatically increased and that any re-profiling of debt is another form of default.
This caused a flurry of risk aversion in the markets; however this is likely to be short-lived. The market has come to expect a second bailout/ default from Greece. What is much more troublesome is the ECB’s recent rhetoric. It is steadfastly against a debt restructuring for any member states, which is what the EU authorities are pushing for. The reason for this is twofold: firstly, it believes that a default would cause contagion to other more systemically important nations in the Eurozone like Spain. Secondly, since last year the ECB has been accepting lower grade collateral in return for its loans, which means it is sitting on billions of peripheral debt.
ECB member Jens Weidman said that the Bank may no longer accept Greek bonds as collateral if there is an arranged default for Athens. This would in essence shut-off Greek banks from the capital markets, causing them to collapse and potentially triggering a global financial crisis, resulting in the 200 pip drop in EURUSD at the end of this past week.
The ECB is talking tough and has a right to voice its concerns, but we believe it will be side-lined and the EU authorities will ultimately determine the solution to the debt crisis. The ECB’s mandate is to promote financial market stability – unleashing chaos into the markets by effectively forcing Greece into bankruptcy would be a clear violation of this mandate.
The bad news for euro bulls is that the Greek situation is likely to get worse; an IMF audit into how well it is adhering to the conditions of its first bailout is due to be released next month, which has the potential to dent investor sentiment further.