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Multiple potential benefits await Greece if it can clinch QE eligibility
If it manages to conclude the second review, Athens has its heart set on the inclusion of Greek government bonds (GGBs) in the European Central Bank’s quantitative easing (QE) programme, which requires the eurozone central bank to deem Greece’s debt sustainable.
Such a development would greatly help Greece’s effort to tap markets so it can refinance its debt and improve foreign investors’ confidence about the prospects of the Greek economy, the Bank of Greece (BoG) recently noted in its annual report.
The notable positive effects are expected to occur despite the limited size of GGBs that could be purchased by the ECB and the National Central Banks in the context of the Public Sector Purchase Programme (PSPP) due to certain restrictions.
These mainly consist of the issue and issuer limits of 33 percent each and the 1 to 30-year range of residual maturity applied to the universe of eligible assets. The maturity range was initially set between 2 to 30 years, but the minimum remaining maturity was reduced from two years to one year by the ECB last December. The maturity range is applied on a rolling basis.
On the back of those restrictions, we estimate that the eligible notional pool of GGBs that could be purchased by the Eurosystem currently stands at around 2.9 billion euros. It will increase to almost 4.2 billion between mid-July and April 2018 and to more than 5 billion after August 2018. The PSPP is due to run at least until December 2017.
The monthly notional amount of GGBs that could be purchased is close to 1.5 billion. This results from the application of the ECB capital key (of around 2.9 percent for Greece) on the maximum monthly amount of 60 billion for ECB expanded asset purchase programme (APP), also taking into account that 90 percent of total purchases is allocated to PSPP.
Impact on GGB yields
Based on certain assumptions and econometric estimates on the correlation between government bond yields, credit ratings and monetary policies in a wide sample of countries, the BoG recently concluded that the direct impact from the announcement of Greece’s eligibility to the QE programme would result in a reduction of 200 basis points of the 10-year GGB yields from the level of around 7 percent in mid-January.
This would mainly stem from the improved investor confidence as the markets will discount the positive impact of future transactions on current bond prices, while the execution of future bond transactions would drive GGB yields even lower, the BoG stressed.
However, the central bank noted that if the inclusion of GGBs in QE is delayed significantly, the impact on bond yields would be lower than initially estimated and would be also dependent on the residual duration until the expiration of the QE programme.
Impact on Greek banks
Lower GGB yields will have a direct positive impact on banks’ capital due to the revaluation gains of their GGB portfolios. At the end of September, Greek banks held GGBs of 5.7 billion euros. Piraeus’s holding stood at 370 million, while the other three systemic banks held GGBs of 1.7 to 1.9 billion each.
Indicatively, Alpha Bank noted in its 9-month results’ presentation that the book value of its GGBs (marked at 70 percent of nominal value), which stood at 1.9 billion in September, could reach their nominal value of 2.6 billion in case the GGB yield would tighten towards Portuguese levels (of 3.7 percent at that time) with a significant benefit (compared to September 2016 levels) of around 700 million on its capital.
Similar positive impact on capital should be expected for Eurobank and National Bank (NBG), which hold GGB portfolios similar to Alpha’s. The benefit for Piraeus would be much lower due to its small GGB exposure.
Greek banks have been participating in the ECB PSPP since last May, having sold more than 10 billion euros of EFSF bonds and recording trading gains of around 230 million in the last three quarters of 2016. As a result, their EFSF holdings have been reduced to less than 29 billion.
Greek banks may not be willing to sell their GGBs to the ECB and might consider increasing their exposure to Greek sovereign debt if it becomes QE eligible, according to banking sources.
In addition, they would also examine their own bond issues as well as increased interbank repos using GGBs, T-Bills and covered bonds as collateral if GGBs are included in the QE programme, allowing them to reap the benefits of improved investor confidence.
Meanwhile, the conclusion of the second programme review coupled with inclusion of GGBs in the QE programme is expected to improve depositor sentiment, which was recently harmed due to a new round of uncertainty, and a portion of cash and funds that still remain outside the banking system could return again to Greek banks.
As we recently noted, banknotes worth 7.7 billion euros have been re-deposited in the Greek banking system in the July 2015 – December 2016 period, while another 7.9 billion were repatriated from funds and deposits abroad over the same period, according to BoG.
Improved depositor sentiment along with further inflows of banknotes and repatriated funds in the wake of QE eligibility is expected to pave the way for the further relaxation of capital controls.
Summing up, the potential inclusion of GGBs in the QE programme, is expected to have a number of direct and indirect positive effects for Greece: It could significantly improve investors’ confidence in the domestic economy and its prospects, facilitate re-access to markets for the state as well as for banks and corporates, and enhance banks’ capital and deposit base.
Such a development would be a key catalyst for Greece getting out of the woods and ultimately entering what would be a virtuous circle for the domestic economy. Clearly, though, there are several hurdles to overcome before this stage is reached.