After 8 years, Greece finally left its adjustment programme, just to be confronted with a harder challenge: financing itself from financial markets. However, by continuing to exclude Greek bonds from its quantitative easing programme, the ECB is making this task even harder. The ECB should reform its eligibility rules to ensure fair treatment of all Eurozone countries.
We are not big fans of quantitative easing – the European Central Bank’s 2.5 trillion euro money creation programme has failed to stimulate the Eurozone economy. However one has to recognize that QE did stabilize the sovereign bond market by reducing borrowing costs for Eurozone governments. Thanks to the ECB, the sovereign debt crisis in the Eurozone was tamed for the time being.
It is however quite paradoxical that the country that suffered most from the euro crisis – Greece – has been excluded from QE since its inception in 2015. Many protested about it, from Yanis Varoufakis to Right-wing members of the European Parliament. In 2016, the Greek Finance Minister Tsakalotos expressed confidence that Greece would finally benefit from QE. However, nothing has happened until now.
So when the Eurogroup reached a historic agreement in June 2018 which completed Greece’s adjustment programme in August, we were hopeful that the European Central Bank would finally let Greece benefit from quantitative easing (QE). After all, if the Greek crisis is indeed over, one would naturally expect the ECB to normalize its treatment of Greek bonds by making them eligible as well.
Such step would come at a timely moment where Greece’s budget, instead of being financed by EU funds, will have to be financed by selling bonds in the market. This is set to be a difficult and costly task, as markets would currently expect the Greek treasury to offer at least a 4.5% interest rate, a much higher price than other Eurozone countries.
“Make no mistake, the burden of gaining the trust of markets and depositors has now fully shifted to the Greek government. Don’t expect building trust among investors to be easier than convincing the institutions.” ECB official Benoit Coeuré recently said.
The above statement however ignores the power of the ECB to help regaining that trust. Just like QE reduced spreads between sovereign debts in the Eurozone, including Greece in the QE programme would finally help in restoring market confidence towards Greece. This would allow Greece to borrow at affordable rates, and speed up the slow recovery currently observed.
Better late than never
Although the ECB is set to stop increasing the overall size of quantitative easing by December 2018, it is not too late to include Greece into the programme. Indeed, next year alone, the ECB will keep injecting more than 180 billion euros through its “reinvestment” policy. This leaves plenty of room for the ECB to start purchasing Greek bonds.
Unfortunately, the ECB does not seem to think of things this way. While most of the EU’s establishment has been celebrating Greece’s exit from the bailout programme, the European Central Bank quietly removed the so called “waiver” which allowed commercial banks to pledge Greek bonds as collateral for the ECB’s open market operations. Strangely enough, such waiver did not apply to QE. By refusing to accept Greek bonds as temporary collateral, the ECB seems to indicate it is even less likely proceed with outright purchases of those bonds in the near future. So what is holding the ECB?
The ECB justifies the exclusion of Greek bonds by referencing its internal rules, and more specifically, its “collateral eligibility framework”. This framework defines what types of assets are eligible for monetary policy programmes such as refinancing operations or quantitative easing. After a modification of the framework in 2005, all assets, including sovereign bonds, must be of ‘investment grade’ (BBB) to be eligible for ECB operations. Greece’s debt securities rating falls far below such level and are therefore ineligible.
“Greece can become part of the quantitative easing (QE) if it has a waiver after the end of the programme: only if there is a waiver. Now the current post-programme enhanced surveillance doesn’t warrant a waiver, and we have made that clear.” Mario Draghi explained at the European Parliament in July 2018 in response to Greek right-wing MEP Georgios Kyrtsos.
Draghi mentioned that the ECB will carry out its own debt-sustainability assessment of the Greek public debt in order to consider whether Greece could be included in QE (presumably through a new waiver). However, it would be highly embarrassing if the ECB concluded that Greece’s debt is unsustainable. This would indeed reveal a profound misalignment of views between the ECB and the Eurogroup over the health of Greece’s public finances. It would be even more awkward since the ECB participates in all Eurogroup meetings – so it could have warned finance ministers earlier.
Time to revise the ECB’s collateral framework
Beyond the case of Greece, there is growing support for changing the ECB’s collateral framework. The European think tank Bruegel voiced strong and reasoned criticism that the current framework is not gradual enough and therefore it tends to be pro-cyclical. Indeed the current framework only comprises of 3 quality levels, which makes the scheme too abrupt. Any small changes in a credit rating can bear catastrophic consequences for the issuing country. As former Central Bank Governor Orphanides recently wrote, “In a panic, declaring government debt as ineligible collateral merely on the basis of private credit ratings rather than on the basis of fundamentals, would virtually inevitably lead to crisis.”
It is questionable why the quality of the collateral is assessed by external rating agencies, thus delegating an important power to private companies which were an important contributing factor to the crisis. Rating agencies have been both accused for their faulty rating of mortgage back securities which were deemed safer than they actually were ; and reversely, they precipitated the euro crisis by downgrading sovereign bonds, triggering a cliff effect on the credibility of Southern member states’ debts. To avoid such self-fulfilling panics, many other central banks including the Bank of England carry out their own credit assessment, so it is odd that the ECB does not do the same.
Thus, the rationale for revising the ECB’s collateral framework is clearly justified and the process for reviewing it should start as soon as possible. A revision of the framework would not only make it easier for Greece to become eligible again, but it would also benefit other member states in the future, besides helping prevent another self-fulfilling crisis.
Fortunately, the ECB has the full competence and authority to change its collateral framework at any time. In fact, the ECB has already modified its framework several times as a response to the crisis. In particular the ECB has repeatedly reduced the quality requirements for many asset classes, from sovereign bonds to auto loans, leasing, commercial mortgages, consumer finance, residential mortgages and loans to SMEs.
Now would be a good time for the ECB to review its collateral framework again. Meanwhile, the ECB should re-introduce a waiver for Greece as part of its temporary framework to make Greek bonds eligible for both open-market operations and most importantly, QE. Hopefully the ECB will make steps in that direction following the upcoming meeting of its Governing Council.