As Greece works towards moving out of recession, the removal of capital controls are essential. But there should be strict conditions before this happens, warn Nikolaos I Georgikopoulos and Michael L Pinedo.

Undoubtedly, 2017 is a key year for resetting the Greek economy from recession to growth. The Greek banking system should have a leading role in this, so that Greece can exit recession as soon as possible and at the same time achieve sustainable economic growth in the coming years.

The recovery of the Greek economy and the achievement of sustainable economic growth require a healthy, functional and viable banking system. Nowhere in the world could sustainable growth be observed if the financial system did not function properly, its key role being the provision of liquidity from those who have surpluses (depositors and investors) to the real economy that displays a lack of funds (businesses and households) through the channel of credit growth.

On the other hand, it is very difficult to draw an effective economic strategy in order to achieve rapid growth in the Greek economy through funding from credit institutions, given the existing restrictions on capital movements (capital controls) in Greece.

What banks must do

So what are the necessary preconditions so that Greek banks can play a pivotal and intermediating role to contribute substantially to the recovery of the Greek economy?

By examining the health of the Greek banking sector, it becomes clear that the lack of (low cost) liquidity, as well as increased credit risks that are inherent in the loan portfolio due to the large stock of non-performing exposures, are the main factors that do not allow the financial system to 'function' and to sufficiently finance the needs of the real economy.

Instead, the capital adequacy of the banking system remains at high levels, and there are no signs of an imminent requirement for a new recapitalisation.

Six prerequisites

Undoubtedly, the 'adverse albeit necessary' restrictions on capital movements significantly hamper the real economy. Consequently, capital controls should be fully lifted as soon as possible. But in order to achieve this objective and to allow the Greek economy to permanently exit the state of capital controls, some prerequisites must be met:

1. The reviews of the Greek financial adjustment programme must be successful without causing further delays in the forthcoming period. It is also necessary to implement all of the remaining structural reforms outlined in the current memorandum ('mnemonion'), as well as the growth-oriented policies that aim to provide an exit from the recession in the Greek economy and the completion of fiscal adjustment.

2. Debt should be restructured, even in the short term at a first stage, after the completion of the ongoing review (December 2016), in order [for debt levels] to become truly sustainable with the 'certification' of a sustainability report by the International Monetary Fund and with an approval by the European Central Bank (ECB). This would automatically mean the integration of Greek bonds in the ECB’s quantitative easing programme.

3. The confidence of Greece’s citizens in the political and the economic system should be immediately restored. To the extent that social and economic uncertainty persists and Greek citizens do not trust the proposed economic strategy, any attempt to revitalise the Greek economy will not yield any meaningful outcome.

4. The restoration of Greek depositors’ confidence in the domestic banking system is deemed necessary. This should be reflected by the return (increase) of deposits. There may not be a complete lifting of capital controls if approximately two-thirds of deposits do not re-enter the system. About €20bn has been withdrawn from the banking system since December 2014 and shortly before the imposition of restrictions on withdrawing capital. Only in this way will banks be able to drastically reduce the emergency liquidity assistance by the ECB and substitute its larger amount with direct borrowing from the ECB.

5. As long as Greece remains within the fiscal consolidation programme, the existing European directive on deposit guarantees up to €100,000 should be applied to the letter and without any exceptions, as this contributes to the development of confidence in the banking system.

6. Banks should focus on the major issue of non-performing loans (NPLs) in order to achieve the targets set by the Bank of Greece that would lead to their immediate reduction in the forthcoming period. In addition, banks should proceed with a wide-ranging restructuring of non-performing mortgages and NPLs of small and medium-sized enterprises through a reduction in interest rates, an increase in the grace period and an extension of the repayment term.

The aforementioned six actions are the necessary preconditions for the release of the Greek economy from capital controls. However, given the fact that the full adoption and implementation requires a considerable amount of time, this will not be in the first half of 2017.

Nikolaos I Georgikopoulos is research fellow at the centre for planning and economic research in Athens and visiting research professor in the department of information, operations and management sciences (IOMS) at New York University’s Stern School of Business. Michael L Pinedo is Julius Schlesinger professor of IOMS.


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