It is time for banking controls in Greece. Delay at this point will only compound the chaos. Consider the following.
Thursday’s meeting of Euro-area finance ministers made no progress toward a deal. That was not surprising. What was more noticeable was the discord that followed. IMF Managing Director Christine Lagarde summed it up: for a Greek deal to happen, there will have to be “adults in the room”. There will now be an emergency leader’s summit on Monday, but absent a major U-turn by the Greek government, that meeting is likely to turn to a discussion of “plan b.”
Against this backdrop, there has been a rapid acceleration in outflows from the banking system, reportedly in excess of €2bn in the first three days of week. Deposit flight likely will intensify tomorrow and Monday. The ECB will hold an emergency phone call this morning to decide whether to expand emergency assistance (ELA) to the Greek banking system from its current limit of €81 billion. To keep the banks open, the ECB will need to provide a significant injection of liquidity.
They should not do it. Greek banks are clearly insolvent. The crisis has caused a spike in non-performing loans, the economy is deteriorating rapidly, and with the Greek government on the verge of default to the IMF, the ECB can no longer pretend that the Greek government bonds that the banks have provided as collateral for past loans are adequate protection against loss. (Arrears to the IMF do not force other creditors’ claims into default, but the political statement of non-cooperation would be powerful unless serious negotiations are underway.) Further, ready access to central bank liquidity has disabled an important source of market discipline on the government, throws good money after bad, and creditor frustration with the continuing demands for financing make the politics of a deal all the more challenging.
The Greek government is likely to resist imposing banking controls, but absent an agreement with creditors controls on deposit withdrawals and cross-border transfers look unavoidable once ECB liquidity support has been curtailed. Controls will buy some time for the government, but how much is unclear. The immediate challenge is fiscal and domestic. The government reported a sharp fall in fiscal revenue last month, reflecting a declining economy and substantial tax non-compliance. In response, it has slashed spending and delayed payments to suppliers and contractors. But large-scale arrears are causing significant payments difficulties in the broader economy, and are not sustainable for long when banks can’t lend. For this reason, I am skeptical that the government can sustain deficit spending for long through creation of IOUs, a informal secondary currency within Greece. How the government responds to these fiscal challenges will go a long way to determining whether controls are a way station to Grexit or, as elsewhere (e.g., Cyprus), breathing space to restructure and adjust within the currency union.
My colleague Sebastian Mallaby has an excellent discussion of the perils for Greece of heading down this path, and he makes a convincing case that Grexit is not an easy option. The converse is also true. The international community has coalesced around the policies needed to put Greece on a sustainable path within the Eurozone. That includes additional debt relief and perhaps as much as 2 percentage points of GDP in new measures this year alone—including to pensions, wages, and taxes—measures that the Greek government has firmly rejected and that would be a major economic and political challenge to pass and implement. If Greece were to accept the deal, Europe would need to provide additional debt relief to make the numbers add up, a point recently emphasized by the IMF. Tough decisions are called for on both sides, and the prospect for bridging this gap is looking increasingly remote. While the temptation thus exists to buy time by extending the current program, trading cash for partial reforms, and putting off negotiations on a third bailout until the fall, it is a “bridge to nowhere” if it doesn’t put Greece on a credible path back to sustainable growth.