Athens is running out of time

Greece has showed first signs of willingness to reach an agreement with its European partners. Athens would do everything in its power to seal a deal, a government spokesperson told Greek broadcaster Skai TV on Friday (12.02.2014). Eurozone's finance ministers are set to meet again on Monday to discuss the Greek crisis.

However, the government in Athens does not have so much time left as the current bailout program expires at the end of this month. If Greece doesn't seek its extension, the country will, for the first time after the crisis broke out, remain without a financial backstop from March 1.

Moreover, Athens would need tens of billions of euros to meet pressing debt repayments in the coming months. Without new money, the government wouldn't be able to fulfill these commitments.

Capital outflows

But the newly-elected radical left government, led by Prime Minister Alexis Tsipras, has so far strongly rejected an extension of the current bailout program. Instead, Athens has made a range of demands including bridge financing for the next six months, an end to the troika of international lenders and a debt restructuring.

The unsuccessful negotiations on these issues have also caused uncertainty among the Greeks, triggering massive withdrawals from Greek banks and sparking concerns of potential bank runs. It is estimated that about five billion euros per week are being withdrawn from the Greek banking system.

The development puts immense pressure on Greek banks, which are no longer able to obtain much needed liquidity from the European Central Bank (ECB). This is because much of the collateral of Greek banks consists of junk-rated government bonds that the ECB has not been accepting since February 11.

Increasing pressure

Banks in Greece are now receiving liquidity via the so-called Emergency Liquidity Assistance (ELA) window, instead. The ECB has just raised the upper limit of the amount of credit that can be lent using this instrument from 60 to 65 billion euros.

However, the central bank would be permitted to continue this program for a longer period only when an agreement is in place between international creditors and Greece, ensuring the solvency of the country's banks. But failing to do so would result in Greece running out of money within a couple of months, thus forcing the country to declare bankruptcy.

Furthermore, a stream of debt repayments is due in the near future. While Greece has to repay 1.4 billion euros to the IMF in March, another 1.4 billion euros of old debts are to be redeemed in June. In total, the country has to repay around 22.5 billion euros this year.

Aid to repay debt

Therein lays the dilemma faced by the government in Athens. The debt burden is so huge that the vast majority of the financial assistance provided by foreign lenders goes to debt and interest payments, instead of reaching the Greek people.

The European Union and the International Monetary Fund (IMF) has so far pumped 229 billion euros into Greece. Out of this striking figure, however, only 27 billion euros (11 percent) was spent on the provision of public services.

In contrast, Greece spent over 40 billion euros on interest payments, and 81 billion euros to redeem maturing loans. Together with the repayments made to the IMF, which stands at about nine billion euros, the total spending on debt servicing has thus far amounted to 132 billion euros, more than half of the total foreign assistance the country has received.

The standoff between the new Greek government and its European partners has so far not spooked global financial markets, as most investors believe that a compromise would be agreed upon in the end – as in previous crises – and a "Grexit" would be avoided.

Short-term shocks

Nevertheless, markets could be unnerved if Greece was forced to reintroduce the drachma, writes analysts at Commerzbank in a research note. "Yields on ten-year German government bonds might see a significant drop falling close to zero, while the risk premium on Italian and Spanish bonds could spike to up to 200 basis points," the analysts estimate.

The exit of Greece from the eurozone would raise existential questions for the entire currency union, with investors "fearing a repeat of Greece's fate in other euro area countries," they noted.

But the analysts do not believe that Grexit would destabilize the entire European banking system. "Foreign banks have massively reduced their holdings of Greek debt since the peak of the sovereign debt crisis in 2011, from over $300 billion to around $50 billion, and a large part of this is hedged. The potential losses for foreign banks would therefore be manageable," said the Commerzbank economists.