The European Central Bank has raised the stakes in its bid to prevent a restructuring of Greek debt, telling euro zone governments it would refuse to accept Greek bonds as collateral in the event of such a move.
Economists expressed doubts, however, about whether the Frankfurt-based central bank would follow through on the threat, and described it as a negotiating ploy designed to halt the momentum toward some form of restructuring.
Greek banks rely on the system of collateral to fund themselves and refusing to accept government bonds as security would effectively cripple them.
The warning came from ECB Executive Board member Juergen Stark at a conference in Athens on Wednesday, although markets latched onto the remarks on Thursday after a German daily reported that ECB President Jean-Claude Trichet had made a similar threat at a closed-door meeting in Brussels on Monday.
ECB officials have warned for weeks that a debt restructuring would have catastrophic consequences for the euro zone and stepped up their rhetoric this week after Eurogroup Chairman Jean-Claude Juncker suggested the bloc was open to a voluntary extension of Greek debt maturities.
For the ECB, according to our statutory obligations, a debt restructuring would undermine the collateral adequacy of Greek government bonds, Stark said.
This means that a debt restructuring would make the continuation of large parts of central bank liquidity provision to the banking system of Greece impossible.
The comments, and a report in the Financial Times Deutschland, that Trichet had issued the same warning to euro zone finance ministers in a heated meeting of the Eurogroup on Monday, weighed on the euro, which stood at $1.4235.
The cost of insuring Greek debt against default also rose and the spreads between Greek 10-year bonds and those of safer German benchmarks hovered at 13 percent, near a record high.
The ECB has warned repeatedly about the knock-on effects of restructuring and its members have been equally dismissive of the idea of a reprofiling in which private creditors would be asked to exchange their bonds voluntarily for paper with longer maturities.
Beyond the impact on the euro zone, the Frankfurt-based central bank may also be concerned about the effect of a restructuring on its own books.
It has bought an estimated 40-50 billion euros in Greek sovereign debt as part of its controversial bond-purchasing program and has indirect exposure via the tens of billions of euros in Greek paper it has already accepted as collateral in its lending operations.
Economists said, however, that no matter how opposed to a restructuring the ECB is, the central bank would ultimately have trouble cracking down on collateral because the consequences for Greece and the broader single currency bloc could be disastrous.
Let's assume we get a situation where Greek banks at short notice have to replace all their collateral, said Gilles Moec, an economist at Deutsche Bank. The seizure that would follow for the Greek banking system would have consequences for the rest of Europe.
I think this is all part of the negotiation process. Deep down the ECB probably knows something has to happen, but they want it to be as mild as possible.
Article 18.1 of the ECB statutes gives the bank a high degree of flexibility in determining what it can and cannot accept from banks seeking short-term loans, stating only that lending should be based on adequate collateral.
A separate section of the statutes which deals with modifications to the monetary policy framework also states that: The Governing Council of the ECB may, at any time, change the instruments, conditions, criteria and procedures for the execution of Eurosystem monetary policy operations.
The ECB has continued to accept Greek and Irish government bonds as collateral in its liquidity operations regardless of their credit rating and could presumably decide to accept voluntarily swapped bonds with extended maturities.
I think they are fighting dirty here to buy time, said Frederik Ducrozet, a fixed income economist at Credit Agricole.
He pointed out that the ECB could play a crucial role in facilitating a voluntary debt swap by refusing to accept Greek bonds that were not exchanged, but said the bank was unlikely to change its stance until it was clear there were no other options for Greece.
I think they will remain on the hardline at the moment and maybe in 3 months or 6 months if Greece fails to meet its targets then the ECB could start to change its communications, Ducrozet said.
The IMF warned Greece on Wednesday that its fiscal adjustment program risked veering off track unless it stepped up reforms. Greek sovereign debt is forecast to rise to nearly 350 billion euros by the end of 2011, or 154 percent of its gross domestic product (GDP).
Many economists say a restructuring of the debt is inevitable, but European governments have promised not to force losses on private creditors before mid-2013, when they will begin attaching Collective Action Clauses (CACs) to the debt they issue.
(Additional reporting by George Georgiopoulos in Athens, Marc Jones in Frankfurt, Annika Breidthardt in Berlin)
(Writing by Noah Barkin; editing by Patrick Graham)