Cablegate: Ecb's Exit Strategy and Reaction to Greece

DE RUEHFT #3274/01 3571211
P 231211Z DEC 09





E.O. 12958: N/A


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1. (SBU) Summary: On December 8, European Central Bank (ECB)
officials told a visiting Treasury delegation that the financial
crisis will increase growth differentials among Eurozone countries,
ultimately increasing pressure on the ECB to address imbalances. The
ECB, however, remains committed to the idea that differentials must
be resolved by national measures. Regarding Greece, the ECB sees it
as isolated in the Eurosystem and under pressure to reform. It rules
out an IMF program for Greece, planning instead its own European
"IMF-style" program (albeit without financial support.) The ECB is
also starting to gradually phase-out its generous supply of
liquidity, without regard to individual countries' needs. The ECB
officials further praised the establishment of the new European
Systemic Risk Board (ESRB), noting that it will encourage closer
interaction between central banks and national banking supervisors.
End Summary.

Growth Differentials and the Stability of the Eurozone
2.(SBU) The ECB expects economic activity in the second half of 2009
to improve unevenly with moderate growth rates in 2010 that remain
subject to uncertainty. The differing national causes of the
financial crisis among Eurozone members pose a challenge for the
ECB, but will not threaten the European Monetary Union (EMU). The
causes include: a collapse of trade because of an overly high export
dependence (Germany), overdependence on the construction and housing
market for growth (Spain), and a lack of wage moderation and fiscal
discipline (Greece). Structural reforms are needed and the ECB will
urge members to adopt concrete measures. But as Frank Moss, ECB's
Director General for International and European Relations, opined,
the "onus is on the national government," which should take adequate
measures to restore competitiveness when faced with growth
differentials. Doing so is "part and parcel of being in a monetary

3. (SBU) Nevertheless, different national policy responses pose a
potential problem for the ECB, ECB Governing Board member Juergen
Stark reported. The first ten years of the Euro worked better than
expected, enabling the ECB to gain confidence. This good track
record will help it tackle future challenges, including the
long-lasting effects of the crisis, such as reduced levels of output
and a lower potential growth rate. Higher growth and inflation
differentials could tempt governments to pressure the ECB,
potentially calling into question the central bank's independence.
Currently, ECB bankers reported, countries suffering most from the
Euro's appreciation already try to pressure the ECB. Any discussion
of a potential break-up of the monetary union, however, is unfounded
and according to Jens Dallmeyer and Barbara Boettcher-Meier of
Deutsche Bank Research, primarily driven by "Anglo-Saxon" outsiders
from the Eurosystem. They agreed that the next ten years will be
more difficult for the ECB than the first. The challenge is "to
ensure that the success story continues."

Greece - A Special Case
4. (SBU) Greece was a frequent topic of discussion in the meetings,
since Fitch had downgraded Greece's rating the day before from A- to
BBB+, making it the only eurozone country to fall below an "A." ECB
bankers saw Greece as a "peripheral" case. Its economic and fiscal
position, "is and has been a disaster for years," Stark said. The
country "lacks the strong institutions and political leadership
necessary for maintaining fiscal control." Board member Stark
pointed to the 100 percent increase of public sector wages,
unreliable statistics, and an explosion of the country's deficit
from four to twelve percent in just a few months. Furthermore,
contrary to Ireland, whose crisis response has been exemplary and
helped to restore the confidence of the markets, Greece has "done
nothing so far." Even though it will be politically difficult for
the Greek government to implement reforms given the fragile
political situation, it has no choice: "They had fun. But now is the
end of the party." Dallmeyer from DB Research concurred that
disenchantment with Greece is very high. "I cannot remember a
country ever as isolated in its peer group as Greece is now in the

5. (SBU) The Greek problem, however, will be resolved within the
Eurosystem. "We will accept the IMF inside the EU but not inside the
EMU," Director General Moss said. Support from the IMF, Stark
explained, "would be perceived as failure of the EMU project."
Instead, the EU will put an "IMF-style program" without money
transfers, which are prohibited under EMU rules, in place. The ECB
is already working on developing the necessary program. "We can be

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clearer on measures to be taken including concrete numerical
objectives by how much the deficit must be cut during what time span
and what kind of institutional reforms must be implemented," Stark
said. While ECB officials ruled out financial assistance to Greece,
Deutsche Bank economists Jens Dallmeyer and Barbara Boettcher
thought some bilateral support may be possible to enable Greece to
meet the conditions imposed.

6. (SBU) Greece has also been a prime beneficiary of the ECB's
unlimited supply of liquidity and its broader definition of
acceptable collateral. (Comment: As part of its so-called "enhanced
credit facility" program initiated earlier this year, the ECB
lowered the minimum rating requirement for assets from A- to BBB.)
The ECB will return to the pre-crisis collateral requirements at the
beginning of 2011, creating a serious risk to Greece if the other
credit ratings agencies follow Fitch and downgrade the Greek
sovereign to BBB+. This would create difficulties both for the
Greek sovereign and for Greek banks, since the ECB would no longer
accept Greek sovereign bonds as collateral. Additionally, when the
first and quantitatively largest of the three one-year unlimited
tender operations of the ECB expires in June 2010, assets that are
now on the books of the ECB will be back on the balance sheets of
banks and could cause problems. Moreover, Frank Moss stressed that
the ECB doesn't take country-by-country considerations into account
in its decision making. It is therefore "up to Greece to adapt, not
the ECB," Francesco Papdia, ECB Director General of Market
Operations, noted.

Phase-Out Strategy
7. (SBU) The ECB will continue the gradual phase-out of
extraordinary liquidity measures begun on December 3, but has no
intention to change its monetary policy for the time being, Stark
said. The ECB will fully satisfy the banks' refinancing needs until
the end of 2009. When current tender operations expire, the
liquidity will be taken out of the market automatically. The
expiration of the first of the three one-year, fixed-rate tender
operations poses a problem, because allowing the 442 billion Euros
to expire would withdraw 75 percent of the liquidity injected into
the market. The ECB instructed member states' central banks to
issue warnings to their commercial banks to avoid an overreliance on
central bank liquidity, but will still have to find a way to smooth
the exit of that much liquidity at one point. ECB Director General
Market Operations Papadia said that although the ECB will
discontinue one-year operations, there will be a higher share of
three-month operations than before the crisis.

8. (SBU) Papadia noted that in hindsight, the ECB's liquidity
supply was too generous. Three one-year operations gave the banks
too much of a sense of comfort instead of prompting them to address
their underlying vulnerabilities. Key issues to reconsider for the
ECB in the future will be: a) the tightening of the collateral
requirements and b) the future role of rating agencies in the ECB's
collateral framework. (Comment: currently only four Eurosystem
central banks prepare their own ratings for bank loans- Germany,
France, Spain, and Austria.) The ECB's dominant consideration on
collateral is the protection of their position, i.e. the reduction
of risk to the ECB. Frank Moss noted that cross-border crisis
management and the streamlining of national deposit guarantee
schemes are also considerations.

ECB and European Systemic Risk Board
9. (SBU) While Frank Moss welcomed the overall new European
regulatory architecture and the "creation of a common rule book,"
which he considered ECB's key achievement, he cautioned that the EU
Parliament could further water down the reforms. The other
challenge is to forge a common interpretation of the new rules. The
European Systemic Risk Board (ESRB), Moss stated, will not have any
real powers. It will only issue warnings and recommendations and
keep an eye on the financial sector. However, it will offer a forum
for closer interaction between national central banks and
regulators. A decision on whether to set up the secretariat as a
separate entity or to staff it with ECB personnel has not yet been

10. Comment: Despite the financial crisis and current decreased
rating of Greece, ECB bankers remained confident in the ability of
the Eurozone to manage its imbalances within its own system. ECB
bankers made it clear that the ECB will define the conditionality of
assistance provided to Greece. Their prognosis that the next ten

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years of the Eurosystem will actually be more difficult than the
first ten raises questions for the future.

11. (U) This cable has been coordinated with US Embassy Berlin and
cleared with US Treasury.


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