ECB Endures Political Drama in Judgment on Greek IMF Arrears

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While Greece and its creditors wrangle into and beyond the eleventh hour, spare a thought for the European Central Bank. It’s the one paying to keep the lights on.

When meeting on Wednesday in Frankfurt, the 25 members of the ECB’s Governing Council must consider their response to Greece’s non-repayment of 1.5 billion euros ($1.7 billion) in International Monetary Fund loans. That could prompt a tightening of terms around the emergency aid that the ECB grants to Greek lenders, or political events may tie its hands.

The ECB approved almost 89 billion euros of stopgap liquidity to Greece’s banking system as talks lurched ever closer to breakdown. That financial entrenchment means the price for the central bank asserting its independence and strictly imposing its rules would be to tip Greece into an abyss.

“The ECB cannot be the angel of the last judgment in the denouement of the Greek drama,” said David Marsh, managing director of OMFIF, a London-based think-tank. “A central bank always has to exist in a political environment. Clearly, it’s got to be aware that its actions may have political repercussions and it must take this into consideration.”

ECB President Mario Draghi is unavoidably caught up in the tactical shifts of Greek Prime Minister Alexis Tsipras. On Saturday, Tsipras made a shock decision to walk away from negotiations to release the final payment of the nation’s 2012 bailout and hold a referendum on the matter. His request on Tuesday for a new two-year rescue package was sternly dismissed by German Chancellor Angela Merkel, and on Wednesday he accepted previous proposals from creditors, with caveats.

Bank Jog

The ECB’s response so far has been to freeze the cap on Emergency Liquidity Assistance for Greek banks, a decision that pushed the government to impose capital controls as a jog on the banking system turned into a run.

The move ended four months of drip-feed increases in support designed to keep lenders alive while preventing the funds from giving the government too much room for maneuver.

According to Thomas Mayer, former chief economist at Deutsche Bank AG and founder of the Flossbach von Storch research institute in Cologne, that strategy failed.

“The ECB has unfortunately been dragged into being the monetary-financing institution that it was not supposed to become,” he said. While the government negotiated over its final bailout payment of around 7 billion euros tied to enacting reforms, “the Greeks extracted something like 90 billion euros from the ECB with no conditionality at all.”

Default Definition

The ECB has maintained the threat that it could increase the discounts that it imposes on the collateral banks must provide against ELA. Currently, the so-called haircuts are based on the assumption that the country will return to international markets -- which looked to be the case until Tsipras came to power in January.

Yet even as the country moves in the opposite direction by not paying the IMF, the ECB may still show tolerance. The three major credit-rating companies have said failure to pay the fund wouldn’t constitute a formal default, and the Washington-based institution prefers the term “arrears.” The IMF said Tuesday that its board would consider Greece’s request for a delay of the payment “in due course.”

Moreover, Tspiras’s effort on Tuesday to reopen negotiations by requesting a two-year bailout from the European Stability Mechanism, and his letter the next day to accept creditors’ proposals as a basis of compromise with some sticking points, presents the ECB with evidence of continuing dialog that might persuade it to wait before tightening the noose.

‘Symbolic Haircut’

ECB officials may even meet concurrently with euro-area finance ministers, who are scheduled to hold a teleconference at 5:30 p.m. Brussels time on Wednesday to discuss Greece.

“We expect either no action or only a symbolic haircut increase,” Barclays Plc analysts led by Christian Keller said in a note. “Pressure regarding the latter could be high, as to acknowledge the higher risk to collateral. However, on balance, the ECB is more likely to decide to wait until after Sunday’s referendum.”

One European government official, who asked not to be named discussing confidential talks, said before governors were due to meet that the ECB urgently needs to see signs of hope in Greece’s talks with creditors to maintain ELA.

‘Unusual’ Situation

The gathering of the Governing Council in Frankfurt is its first scheduled meeting there in two weeks. In that time, the political landscape may have shifted, but the question faced by officials remains similar to one they’ve tackled in multiple telephone conference calls over that period.

“In Frankfurt, we’ll have to discuss a possible extension of ELA again,” Governing Council member Ewald Nowotny said in Vienna on Tuesday. “I don’t want to say any more about it, but it’s clear that we are in a situation that is very unusual.”

The ECB’s actions have moved with the political tide -- and they are likely to keep doing so as long as the euro area’s economic recovery remains frail, according to Stephen King, chief global economist at HSBC Holdings Plc in London.

“The ECB is in a very difficult position alongside everyone else, but its mandate is clear,” he said. “At the end of the day, the ECB will say that it’s got to hit its inflation target. And anything that makes things worse, let’s say from the point of view of lower growth or a collapse in economic activity, would require it to act to prevent that from happening.”

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