The risk of capital controls is mounting as Greece snubs European demands for a new set of budget proposals before a crunch meeting of finance ministers on Thursday.
With savers withdrawing bank deposits at a record pace and lenders relying on more than 80 billion euros ($88 billion) of Emergency Liquidity Assistance to survive, the European Central Bank’s continued help is key to Greek lenders.
Unless ministers can produce a shock result in Luxembourg this week, the hawks on the ECB’s Governing Council may begin to step up their calls for restrictions on ELA operations. While Greece says it has no plans for such limits, the government may have no choice but to limit withdrawals if the banking system’s life support is shut down.
Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics, puts the chances of capital controls being implemented in Greece at 65 percent.
“That’s what we are heading for,” Kirkegaard said in a telephone interview on June 15. “The window for the Greek government to change its mind is narrowing as we speak.”
Here are some answers to frequently asked questions, based on conversations with economists and analysts:
How would it happen?
The most likely scenario is that a breakdown in talks would prompt European governments to tell Greek Prime Minister Alexis Tsipras that he can’t expect ECB emergency funding to continue for much longer. He would then be faced with a choice: let the banks collapse or erect capital controls.
And what if Greece misses a debt payment?
Much of the collateral pledged against ELA is government-guaranteed bonds, and Greek sovereign notes, including treasury bills. So if Greece missed a debt payment, euro-area central bankers would probably decide the lenders are no longer eligible for emergency cash because the guarantor is not solvent. Alternatively, the ECB could impose a very high discount on the face value of Greek collateral, thus setting a hard cap on maximum potential ELA.
The ECB might even shut down ELA immediately, forcing Tsipras to decide on the spot.
How would capital controls work?
They would hurt.
No one knows the specifics for Greece, but here’s what happened in Cyprus: ATM withdrawals were capped at 300 euros a person per day. Transfers of more than 5,000 euros abroad were subject to approval by a special committee. Companies needed documents for each payment order, with approvals for over 200,000 euros determined by available liquidity. Parents couldn’t send children that were studying abroad more than 5,000 euros a quarter. Cypriots traveling abroad could carry no more than 1,000 euros with them. Termination of fixed-term deposits was prohibited, while payments with credit and debit cards were capped at 5,000 euros. Checks couldn’t be cashed.
How would capital controls be put in place?
An element of surprise helps. In Cyprus it started with a long bank holiday, between March 16 and March 28, 2013. That gave the country time to negotiate an accord with euro-area member states and the International Monetary Fund. Banks re- opened with restrictions in place and a recapitalization plan for the country’s financial system, which included the imposition of losses on deposits.
It’s up to the government. Under a 1993 law, the central bank governor can impose restrictions, but he needs the finance ministry to approve his decision on the same day.
How long might it last?
There’s no real limit. Cyprus kept controls in place for two years, even though they were supposed to be a temporary emergency measure. Limits on transactions gradually eased over the two-year period, before being lifted completely in April 2015. Experience from other countries, including Iceland, shows that once in place, they can only be removed gradually, after a long period of time. Iceland’s government presented a bill this month to lift capital controls implemented in 2008.
What other impact would they have in Greece?
They would buy time. That could give Greece the breathing space to strike a deal with creditors over a bank holiday, albeit at a huge cost. The limit on corporate transactions and deposit withdrawals would hurt retail sales, tourism, industry, imports and virtually every other sector of economic activity.
Would Tsipras have any options?
Not really. If the government let banks hit the limits on emergency funding, the financial system would run out of money within days with savers rushing to withdraw as much cash as possible, while they still could.
That would almost certainly push Greece out of the euro area since no economy can function without liquidity. Even if the government plans to leave the currency bloc, capital controls would still make sense, as they would stop the clock until it manages to print a new currency.
Are capital controls legal?
In very rare cases. While the free movement of capital is one of the four basic freedoms of the European Union, restrictions are possible under “strict conditions on grounds of public policy or public security.” The European Commission allowed Cyprus to do it, the only instance on record, saying there was significant risk of “complete destabilization of the financial system.”