Skip to main content

Greece: Default Contingency

Volume 728: debated on Monday 20 June 2011


My Lords, I shall now repeat a Statement that has been made in another place by my honourable friend the Financial Secretary to the Treasury. The Statement is as follows:

“Honourable Members will be aware of the recent developments in Greece. There has been considerable media speculation about what this means for the Greek adjustment programme and potential market reactions. I am not going to engage in speculation on what may or may not happen, but give the House an account of the facts as they currently stand.

Let me begin with some background on Greece and the financial assistance package. The international financial assistance package for Greece was agreed in May 2010. The package is composed of two elements: a loan of €30 billion from the International Monetary Fund, and €80 billion of bilateral loans from euro area member states. Although they were created at a similar time, neither the EFSM, which is backed by the EU budget, or the euro area-only EFSF contributed to the package for Greece. The adjustment package requires Greece to undertake significant adjustment efforts.

There are some very difficult questions that Greece has to address now, because of the assumption when the package was put into place that Greece would be able to access market funding again in 2012, which looks unlikely in current market conditions. The House will also be aware of political developments in Greece and that a new Cabinet has been appointed; the Government will soon be subject to a vote of confidence in the Greek Parliament. The Greek Parliament will also be voting on a medium-term fiscal strategy, which is a key element of the conditions attached to the current adjustment programme, later this month.

Against this backdrop, the euro area member states have been discussing next steps. The euro group released a statement today calling on,

‘all political parties in Greece to support the programme’s main objectives and key policy measures to ensure a rigorous and expeditious implementation’.

The statement also said that Ministers will,

‘define by early July the main parameters of a clear new financing strategy’.

This is a statement from the euro area member states. Let me be clear: the UK has not been involved in those discussions. We are not participating directly in the May 2010 package of support for Greece and there has been no formal suggestion either of UK bilateral loans or for use of the European financial stabilisation mechanism, which is backed by the EU budget. The UK only participated in the May 2010 package for Greece through its membership of the IMF. So the burden of providing finance to Greece is shared between the IMF and euro area member states, and we fully expect this to continue. Our position on this is well understood in the euro area.

The UK believes that the international community needs a strong International Monetary Fund as an anchor of global economic stability and prosperity, and over the past few years we have seen how important that role can be in times of crises as the IMF has taken swift and decisive action to support the global economy. There is of course no room for complacency. The Treasury, together with the Bank of England and the FSA, is monitoring the financial system, including the euro area, on an ongoing basis. Many scenarios are considered as part of the normal policy development process, but honourable Members will agree that it would not be appropriate for me to be discussing the detail of those scenarios. May I also remind honourable Members that UK banks have little direct exposure to Greece?

The continuing uncertainty in the euro area is also a reminder of the benefits of taking early action to stabilise and recapitalise the banks, as the UK has done. The UK banking system has developed a strong capital position, which has allowed it to become more resilient and will help insure it against future risks. UK banks have made good progress in sourcing funding despite difficult market conditions.

The difficulties faced by eurozone countries such as Greece and Portugal reinforce why it is right to pursue the course we set last year to tackle the deficit. The House should reflect that our deficit is larger than that of Portugal, but our market rates are similar to those of Germany. The action we have taken to strengthen the country’s finances stands us in good stead during this period of instability in the eurozone. No one on either side of this House should lose sight of the importance of these decisions in protecting the UK economy”.

My Lords, that concludes the Statement.

My Lords, I am most grateful to the noble Lord for repeating as a Statement the answer to an Urgent Question given by the Financial Secretary in another place. I must begin by congratulating him on the feat of speaking for a full four and a half minutes without referring for a moment to the substance of the Question asked. However, he still has some way to go before acquiring the skills of Mr Alan Greenspan, who famously qualified his speeches when chairman of the Federal Reserve by declaring that, “If anyone understood me, I misspoke”.

Of course, everyone will agree that we live in dangerous financial times and it is incumbent on all those in authority to take care when commenting on market-sensitive information, even to the extent of not answering legitimate parliamentary questions. However, the other fundamental aspect of these uncertain times is that it is important to plan for the worst, even as we hope that it will not happen. Assurance that the Government are indeed planning for the worst will enhance rather than reduce market confidence. Without going into any analytical detail, will the noble Lord tell us what is the Treasury’s current worst-case estimate of the potential exposure of UK financial institutions should there be a disorderly Greek default? Even if he will not answer that question, in the event of market disorder will the present Government stand behind UK financial institutions as the previous Government did? Any worst-case estimate should not, of course, refer just to direct exposure to Greek sovereign and private debt, as the noble Lord did just now, but to the exposure to other jurisdictions that might reasonably be assumed to suffer contagion from a Greek default. Just as the collapse of Lehman Brothers inflicted such a shock on the western financial system that the wholesale funding markets froze, pushing major banks into insolvency from which they had to be rescued by the state, so in similar fashion a default in Greece could produce knock-on effects. Of course, all these effects may already be priced into the market—we hope that they are—but we must plan for the worst.

As the noble Lord will be aware, Mr Michael Cohrs, a member of the new Financial Policy Committee of the Bank of England, has stated that what keeps him awake at night is the interconnectedness of the system, which could create ripple effects in financial markets throughout Europe and beyond. Without referring to any particular market or giving any other detail, what is the Treasury’s worst-case estimate of the scale of those ripple effects as they might impact the UK?

We also learnt from the Lehman collapse that the consequential fall in bank lending to households and industry—Lehman had been growing at more than 20 per cent a year and then ceased to grow at all—resulted in a fall in GDP from which the UK still has not recovered and, again in consequence, led to a sharp rise in the Government deficit. What contingency measures have the Government put in place to ensure that lending to industry and households will not be cut in the face of any market turmoil produced by a Greek default? Industry in particular needs to be confident that lending will be available at reasonable cost. Will the Minister guarantee that at the very least the lending targets of Project Merlin will be attained? If the eurozone economic problems put upward pressure on the UK deficit, will the Government revise their deficit reduction policy?

Finally, given the potential damage to the UK economy of financial disorder in the eurozone, does the Minister accept that it is very disturbing that Her Majesty’s Government seem to take pride in the fact that they are playing no part in the development of UK policies that will minimise future damage to the UK? Is it not time for the Government to be more proactive in Europe in pursuit of Britain’s best interests?

My Lords, I shall try to respond to the noble Lord’s questions one by one. First, he asked about the exposure of UK banks to Greece—not only the direct exposure but the wider exposure. It is important to recognise that the exposure of the UK banks to Greece is modest relative to that of other countries. For example, the exposure of the UK banks to the Greek public sector is $4 billion, which compares with the $22.7 billion exposure of the German banks to the Greek public sector. The total exposure of the UK banking system to Greece, including other credit commitments, is of the order of $19.2 billion. To put it into context, that compares with outstanding credit commitments to Portugal of more than €30 billion and to Ireland of the order of €180 billion.

I will not comment on what the ripple effects might be. In repeating my honourable friend’s Statement that the Treasury, the Bank and the FSA are running a whole range of scenarios against which we test the resilience of the UK system at any one time, I refer the noble Lord, Lord Eatwell, and other noble Lords to the financial stability report—the regular six-monthly report—that will be forthcoming from the Bank of England within the next few days, which will no doubt give an updated assessment in the wider context of how the Bank sees these matters.

On the question of contingency measures, the critical issue here is that the UK banks have been recapitalised and have been through stringent stress tests. They continue to be subjected to the appropriate stress tests by the FSA. They are in a strong position. The Merlin agreement has been signed. It is a much more comprehensive agreement than anything that the previous Government had to ensure the continuing flow of credit, particularly to small and medium-sized enterprises. I agree with the noble Lord that this is a critical issue. There is absolutely no suggestion that any of the events that we are talking about in Greece will have a direct impact on the ability of the banks to rise to the commitment they have made in the Merlin agreement.

The other thing that is absolutely critical here is that the UK continues to retain the utmost confidence of the international markets. The fact that interest rates on the 10-year benchmark gilt are this evening standing at 3.22 per cent, with spreads that have narrowed against the benchmark German bund since the general election, shows the confidence that the international markets have in the strong position of the UK. Those low interest rates enable the banks to fund themselves and to lend on to British small and medium-sized enterprises in order to underpin the recovery of the economy.

That takes me directly to deficit reduction. I am very grateful to the noble Lord for feeding me the lines which make the critical points, because it is only as a result of sticking to the deficit reduction plan that we have the low interest rates that mean that our businesses can be supported by the banks in this very difficult international climate. If we were doing what the shadow Chancellor proposed last week—unfunded tax reductions which would cost £51 billion over the lifetime of this Parliament—we would very soon lose the confidence of the international markets, our interest rates would zoom upwards and our banks and, indeed, individual lenders would be in a very serious position. Therefore, we will stick to our deficit reduction plan, as recently endorsed by the IMF in its latest report.

The noble Lord referred to our position in Europe and our contribution to the debate. Noble Lords who were present for our very interesting debate on Thursday of last week on your Lordships’ European Union Committee’s report on EU economic governance will have heard me explain at length how we are fully involved at every stage in discussions to make sure that the eurozone arrangements strengthen fiscal governance and that we drive forward the wider market reforms of the 2020 vision. The UK is absolutely central to discussions ensuring that what we need in Europe to get us out of the weak situation that others are in—this applies inside or outside the eurozone, but particularly within it—are the market reforms that will bring sustainable growth and ensure that we do not have these sorts of Greek problems into the future.

My Lords, would my noble friend like to comment on press reports that Standard Chartered Bank is ceasing to be involved in short-term interbank transfers with European banks? Does he believe that to be true? Is it happening with other British banks? If so, what are the implications?

My Lords, I am not going to comment on what is going on in the markets and with individual banks at all, and I am sure that my noble friend would not expect me to. However, I would make the point, which was also made in the Statement, that UK banks have been able, in very tough market conditions, to improve their funding position very considerably over the past year and more. The overall situation of the interbank market is far better—although we should not take any of these things for granted—than it has been at points during the financial crisis. It is therefore important, as my noble friend reminds us, that confidence within the banking system enables there to be liquidity. As I say, we are in a much better position in that respect than we were during the financial crisis itself.

My Lords, I start by congratulating the Minister on taking longer to answer questions than he did to repeat the Statement given by his honourable friend in the other place. One might suggest that the reason we have low interest rates and banks are not lending is more to do with the fact that the economy is moving back towards recession than for the reasons that the Minister gave. Let me ask three short questions that I think can be answered by short and quite factual answers. First, have the Government absolutely ruled out any use of the EFSM in support of Greece or any other European nation, over and above the commitments already made? Secondly, has the Bank of England accepted Greek sovereign credit as collateral for loans made by the Bank of England to the European Central Bank, and therefore for loans on which the Bank of England is exposed? Thirdly, are we as a country exposed to the need to recapitalise the ECB should Greece default on its sovereign debt?

On the role of the EFSM, I would refer the noble Lord to the words of the French Finance Minister, Christine Lagarde, when recently interviewed on the BBC. She talked about the package for Greece being one of bilateral loans, and she saw the likelihood of any future support for Greece as a continuation of that bilateral arrangement. So there has been no question of using the EFSM in the context of Greece. As for the question on the Bank of England, I am certainly not going answer for what the Bank of England does or does not take in—nor would the noble Lord, Lord Myners, for one minute begin to think that I would start answering questions about the bank’s collateral policies. As to the capitalisation of the ECB, that is an entirely hypothetical question, as the noble Lord knows full well.

My Lords, is it not apparent that the Greek economy cannot become competitive in the foreseeable future at its present exchange rate? Greece will be condemned to an endless succession of deflation and bailout unless it leaves the euro. Is it therefore not extremely important that discussions by the British Government and in the European Community should take place on how to minimise any collateral damage should that come to pass?

My Lords, I am not sure that I entirely accept my noble friend’s starting premise. The position is that Greece is a member of the eurozone, and the eurozone will continue to be the eurozone. We want to see the strengthening of fiscal and economic discipline within that zone. When the IMF put together and led the programme that Greece signed up to—which had elements of fiscal consolidation, structural fiscal reform and wider structural reform—it was done precisely in the context of Greece continuing to be a member of the eurozone, and that is the continuing position. The package has been put together and the new Government have some decisions to take. The IMF is coming up to its regular review before the next drawdown of the package, but that is entirely in the context of Greece being able to finance itself on an ongoing basis within the eurozone.

Has my noble friend seen the extraordinary anti-German graffiti and the slogans being shouted by the crowds in Athens? Does that not illustrate what Professor Martin Feldstein, the Nobel prize-winning economist at Harvard, has always said—that the euro, far from bringing countries together, increases tensions between them? Can my noble friend also explain what sense there is in Ireland and Greece borrowing more money to lend to Portugal, and Ireland and Portugal borrowing more money to lend to Greece?

My Lords, I have not been on the streets of Greece or seen what is going on in Athens, but clearly it is regrettable if anti-German sentiments are being expressed on the streets there. However, I have not been following the detail of the riots. The main thing is that we need to support the Greek Government and encourage them, as the eurozone Ministers have done in their statement today, to progress their package and enable the IMF to complete the upcoming assessment. As for the second-order effects of who needs capital where in order for loans to flow, my noble friend reinforces the point that this is a very interconnected system and the ongoing work on the short-term and medium-term stability of the eurozone has to be mindful—as we have been reminded already this evening—of the interconnectedness of the systems at every level.

My Lords, is it not the case that this is not a euro crisis, as many commentators have been trying to pretend, but a Greek funding and fiscal crisis caused by excessive borrowing by the Greeks, irresponsible lending and mispricing of risk by lenders? It is not the first time that we have seen that in the past year or two. Does the Minister agree that this would have arisen irrespective of the currency that Greece happened to have? It would have happened whether Greece had been in the dollar zone or the pound sterling zone or still had the drachma. Secondly, to avoid the risk of a considerable panic, is not a renegotiated package for Greece necessary, providing for an orderly restructuring of its debts, a credible series of repayments and a set of definite figures for offsets and provisions by Greece’s creditors? Is it not time that we began to think in those terms? Thirdly, is it not the case that Greece leaving the euro or a Greek devaluation is the opposite of what is required? If Greece went back to the drachma, it would of course greatly enhance the value of its euro debts—and its debts are primarily in euros—but that would increase the burden on Greece and increase the portion of Greek assets that overseas lenders and investors would have to write off. Such a move would be counterproductive and damaging from our point of view as well. Moreover, devaluation never works as a stimulus to growth unless wage bargainers are under monetary illusion and cannot tell the difference between nominal and real wages and do not ask to be compensated for the reduction in real purchasing power. That is a most unlikely situation for Greece at the present time.

I agree with the noble Lord, Lord Davies of Stamford, that if the UK continued with the excessive deficit policies of the previous Government, we would be in a terrible mess in this country. Whether you are in or out of the euro makes no difference, and the UK would be experiencing considerable problems if we had not gripped the deficit. I agree with the implication of his analysis on that point. On the second question about sustainable financing, that is precisely where the IMF starts its assessment of debt sustainability. The critical first plank of sustainability for Greek debt hinges on Greece sticking to its agreed fiscal consolidation path. All else flows from that. As for the Greeks or anyone else leaving the euro, that is a hypothetical question and not one that we should spend any time on.

Does the Minister agree that it is critical not just for Greece but for the UK economy that there is not a disorderly Greek default? In that circumstance, does he agree that the least worst option in what is a difficult situation is to agree an orderly re-profiling of Greek debt? If so, will the Government support moves by the eurozone Finance Ministers to bring about such a re-profiling?

I certainly agree with my noble friend that the last thing anyone wants is disorder, whether default or anything else. As I made clear, the next steps are, first, a question for the eurozone itself. We are not directly involved in the eurozone discussions. To address my noble friend’s point, the statement from the euro group today reads:

“Ministers agreed that the required additional funding will be financed through both official and private sources and welcome the pursuit of voluntary private sector involvement in the form of informal and voluntary roll-overs of existing Greek debt at maturity for a substantial reduction of the required year-by-year funding within the programme, while avoiding a selective default for Greece”.

As I said, that is a matter for the eurozone Ministers, but I think that they are addressing the issue in the way that my noble friend suggests.

Would the Minister care to remind the House of the percentage of, first, the euro area, and, secondly, of the European Economic Area, of which we are a part, which is constituted by the Greek economy? I would not say that it is peanuts, but is it not a rather low percentage? If Europe wished to, could it not help to restructure the Greek economy—with stringent terms, by the way? Would not the whole House stand behind that policy agreed around Europe and say that we want it to work—God’s speed, we want it to work? Are there not some Members of the House who do not want it to work?

I am happy to confirm that Greece is a relatively small part of the euro area but, as we have already identified this afternoon, Greece is interconnected, as are all the European and global financial markets. Therefore, one should not in any way trivialise the Greek situation and the capacity for difficulties in the markets.

That said, it is also important to be clear about the lines around whether the UK should or should not be involved in these matters. We are not a member of the eurozone; we are not going into the eurozone; and we are not going to make any preparations to enter the eurozone in the lifetime of this Government, this Parliament. We must make sure that, on the one hand, we are not part of any ongoing and permanent support mechanism for the eurozone; at the same time, we have to play a full part to ensure that the eurozone economic governance is fit for purpose.

Does my noble friend agree that if relatively less or more successful countries or economic areas are to share a currency, there is a requirement for substantial ongoing transfer payments, as is the case within the US and even within the UK? Secondly, does he by any chance know roughly what proportion of Britain's exports to the eurozone are to what I would call hard northern Europe, compared to softer southern Europe?

I am not able off the top of my head to break down the analysis of our exports, and I am not quite sure where my noble friend would draw the line between hard and soft. The critical point here is that more than 40 per cent of our exports go into the eurozone. Of course, they are generally distributed in relation to the size of economies, with Ireland, as we discussed in relation to the Irish package, having for historical reasons a disproportionately large share. My noble friend makes the point that it is absolutely in the UK's interest to ensure that the eurozone economies are successful, because that is where the largest part of our exports go.

Does my noble friend think that a new set of arrangements made within the euro area by the IMF for Greece will work this time? It did not work last time. Unless there is some confidence that new arrangements made to support Greece will work, in the sense that they can restore the Greek economy—there is very little sign that the Greeks are able to take any medicine which would restore it to health—would we not be better served by working within Europe to help our European friends understand that letting Greece remove itself from the eurozone and take the default that it clearly is in is in everybody's interest?

My noble friend Lady Noakes asks a very good question. It is inevitable that people will ask: was the package appropriate? One should take comfort from the fact that the IMF has a long and successful record of implementing restructuring programmes. The IMF programme for Greece was put in place in market conditions and with a market outlook somewhat different from that which Greece and the eurozone subsequently encountered. The first requirement is for the Greek Government to be encouraged to get back on track, to stick to the agreed fiscal consolidation path. Beyond that, it is for the IMF to see what needs to be done. The key thing is for the original plan to be back on track. I therefore think that we should not at this point second-guess whether the plan is or is not appropriate.

I will not be drawn into whether the Greek situation would be better in one hypothetical scenario or another.

My Lords, does the noble Lord agree that, however brave the Greek Prime Minister is —he has shown extraordinary guts and determination—and however much a new Greek Government might wish to pursue the austerity programme and the conditions being laid down, there must be room for doubt whether any Greek Government can secure the degree of self-discipline within the country that would enable them to meet the conditions of the IMF and of the other European countries? That being the case, does the noble Lord not agree that the great interest of the United Kingdom Government lies in co-operating as closely as possible with our eurozone partners in putting together contingency plans to meet whatever eventuality may occur, because the Greek Government are extremely unlikely to be able to live up to their promises?

My Lords, I am not going to be drawn by my noble friend Lord Tugendhat into giving a commentary on Greek politics, which I am not qualified, in any case, to do. However, the Greek Parliament will hold a vote of confidence on the new Government very soon—I believe that it may be tomorrow. Critically, the Greek Parliament will vote on a medium-term fiscal strategy consistent with the agreement into which they have entered. That vote in the Parliament is expected to be later this month. I think that it would be wrong to question the commitment of the Greek Government and Parliament to the package. On contingencies and close co-operation, I can only confirm that, either in terms of what is being done by the authorities in the UK or in co-operation with our European partners, we will certainly look at a wide range of contingency plans and scenarios.