Greek Bonds may Soon be Included in ECB Purchases

The ECB does not include Greek bonds in its sovereign bond purchase operation.  However, the progress is being made, and it is possible that starting early next year, the ECB will buy Greek bonds.  

Greece Deputy Finance Minister Chouliarakis told the EU Parliament that a staff-level agreement is possible before the end of the year.  There are two challenging issues:  labor market reforms and primary budget target.  

Reforms in the labor market include collective bargaining and dismissals, as well as n industrial action rules.   Collective bargaining reportedly broke down after the 2012 reforms.  That said, Greece's largest unions have called a general strike for Thursday to protest the tax hikes and labor reforms. 

In May, the Greek government agreed to post a primary budget surplus (excluding debt service costs) of 3.5% (of GDP).  The Eurogroup of EMU finance ministers reiterated the importance of this agreement and wanted the 3.5% target to be maintained after 2018.   It is not simply that Greece does not want to maintain such a large primary surplus indefinitely, it is also that economic literature suggests it not particularly likely or effective.   Sometime after 2018, Greece wants to reduce the primary surplus target to 2.5% (using the 1% reduction to be used to lower taxes, leaving aside dynamic scoring) and then 2% over the long term.  

The European finance ministers continue to demand more from Greece.  They called on Prime Minister Tsipras to adopt "serious" reforms.  However, it is the finance minister, not the Greek government that is the most formidable obstacle preventing the IMF's participation.  

The finance ministers offered a few accounting ploys to reduce Greece's cumulative debt by 20 percentage points (relative to GDP) through 2060.  These measures include easing the repayment schedule, waiving a coupon penalty, and swapping debt to mitigate interest rate risks. 

The IMF says that these measures are insufficient to put Greece's debt on a sustainable path.  It argues that the fiscal targets are not realistic. The finance ministers have ruled out nominal reductions in Greece's obligations, but the IMF demands quantifiable and concrete debt relief for Greece.  Because this has not been forthcoming, the IMF is unlikely to participate in a new loan facility.  

Reaching a new staff agreement would recognize the progress Greece is making and underscore the commitment to additional measures.  The staff agreement implicitly assumes that the debt is sustainable.  This is what the ECB needs to hear before Greek bonds can be including in its QE operations.  It would boost confidence that the ECB will buy Greek bonds if the IMF also found Greece's debt was sustainable.  With the disagreement between the finance ministers' assessment and the IMF's, the ECB is in an awkward position.  Even if it conducts its own sustainability assessment, which it says it will do, it will be difficult to override the finance ministers.  

The ECB  already accepts Greek bonds as collateral for loans to Greek banks.  It also has bought EFSF bonds from Greek banks under the asset purchase program.  Buying Greek bonds is an incremental step.  The amounts will be small.  It ought not to be surprising if the ECB includes Greek bonds by late Q1 17.  

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