Tuesday 27 September 2016

What happens if Greece defaults on its International Monetary Fund loans?

Published 30/06/2015 | 14:22

Greek Prime Minister Alexis Tsipras waves as he leaves his office at Maximos Hall after a marathon meeting in Athens
Greek Prime Minister Alexis Tsipras waves as he leaves his office at Maximos Hall after a marathon meeting in Athens

Cash-starved Athens has resorted to extraordinary measures to avoid defaulting to the IMF. But what would be the fall-out of a disorderly default?

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The Greek government faces the prospect of becoming the first developed nation to ever default on its international obligations.

After a harrowing five months, and in a drama of soft deadlines, the cash-strapped government now faces a €1.55bn payment to the International Monetary Fund due at 11pm tonight.

With negotiations have broken off in dramatic fashion last week, a cacophony of voices on Syriza's Left have vowed to prioritise domestic obligations unless creditors finally unlock the remainder of its €240bn bail-out programme. Greece only avoided going bust earlier this month after the government has asked for a Zambia-style debt bundling which will now be due on June 30.

The rhetoric is a far cry from February, when Greece's finance minister pledged his government would "squeeze blood out of a stone" to meet its obligations to the Fund.

Greece owes €9.7bn to the IMF this year. Missing any instalment to the IMF would see the country fall into an arrears process, unprecedented for a developed world debtor.

Although no nation has ever officially defaulted on its obligations in the post-Bretton Woods era, Greece would join an ignominious list of war-torn nations and international pariahs who have failed to pay back the Fund on time.

What happens after a default?

In choosing to bundle up four separate June repayments, Greece avoided triggering an immediate default.

But in the event of a delayed repayment, according to IMF protocol, Greece could be afforded a 30-day grace period, during which it would be urged to pay back the money as soon as possible, and before Ms Lagarde notifies her executive board of the late payment.

However, with talks have broken down in acrimonious fashion between the country and its creditors, Ms Lagarde has said she will renege on this and notify her board "immediately".

Having spooked creditors and the markets of the possibility of a fatal breach of the sanctity of monetary union, Greece may well stump up the cash if an agreement to release the country more emergency aid is reached (that's looking increasingly unlikely however).

But should no money be forthcoming however, the arrears process may well extend indefinitely.

Greece's other creditor burden would also start piling up, with the government due to pay another €6.6bn to the European Central Bank in July and August.

Stopping the cash

Although the exact process is uncertain, falling into a protracted arrears procedure could have major consequences for continued financial assistance from Greece's other creditors - the European Central Bank and European Commission.

"If Greece defaults to the IMF, then they are considered to be in default to the rest of the eurozone," says Raoul Ruparel, head of economic research at Open Europe.

The terms of Greece's existing bail-out programme stipulate that a default to the IMF would automatically constitute a default on the country's European rescue loans.

"Such a scenario would risk the European Financial Stability Facility (EFSF) cancelling all or part of its facility or even declaring the principal amount of the loan to be due immediately," say analysts at Bank of America Merrill Lynch.

Should the EFSF take such a decisive move, it could activate a range of cross default clauses on Greek government bonds held by private investors and the ECB. These clauses state a default to one creditor institution applies to all.

The political and market damage that may ensue would be substantial. Popular sentiment in creditor nations would turn against the errant Greeks, while the position of the ECB in particular could quickly come under the spotlight.

The central bank has kept Greek banks on a tight leash, maintaining that it would only restore normal lending operations to the country once "conditions for a successful completion of the programme are in place".

A wave of defaults may force the ECB into finally pulling the plug on the emergency assistance it has been providing in ever larger doses since February.

Telegraph.co.uk

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