The European Central Bank has three alternatives on how to deal with the Greek issue, according to a Bloomberg analysis.
The author of the report, Mohamed El-Erian, says that the ECB will be under pressure to play the important role of Greece’s “life support system.” As its board of directors will meet on April 29, they must decide how much emergency liquidity they should extend to keep Greek banks afloat and on what conditions.
According to the author, the ECB has the following alternatives on what to do with Greece:
1. Pretend and extend. The ECB, through the Emergency Liquidity Assistance scheme, continues exceptional funding to Greece’s central bank. “This would be done under the pretense that it is helping Greece deal with a liquidity problem instead of acknowledging the country’s true predicament, deep economic and solvency deficiencies. This approach has the advantage of keeping options open in the hope that Greece and its creditors will finally break through to decisive policy and financial solutions,” El-Erian says.
The downside is that this is a risk for the ECB as Greece, so far, has not shown any signs of reliability on dealing with its fiscal problems and negotiations with creditors have stalled mainly due to the country’s fault.
2. Pull the plug. The ECB closes the liquidity tap to Greece. Liquidity support would be ineffective without Athens taking any measures to improve its economy. Additional assistance could continue on the condition that Greece implements reforms that lead to growth.
This scenario would lead Greece to default on loan payments, thus increasing the risk of the country exiting the euro zone.
3. Pull the plug as part of a comprehensive Plan B. In this case, the ECB stops liquidity support as part of a plan to bring “an orderly pivot for both the euro zone and Greece. The ECB would seek to minimize the risk of Greek contagion and disorderly spillovers to other economies (such as Cyprus, Italy, Portugal and Spain) by expanding its funding windows for both governments and financial institutions.” It would also step up the quantitative easing scheme while Europe is working on an interim arrangement for Greece.
According to the Bloomberg analysis, the ECB would most likely opt for the first scenario, extending the ELA scheme and pretending that sooner or later there will be a solution to the Greek debt problem. This, of course, unless bank runs continue and Greece’s demands for liquidity are overwhelming.
El-Erian argues that no one on either side — Greece or international creditors — wants to go down in history because he caused a country to exit the European common currency for the first time. And this is the main reason the ECB would follow the first scenario.
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