Politicians want Greece to remain in eurozone, so the central bank must bend a little Getty ImagesGreek Finance Minister Yanis VaroufakisThe European Central Bank faces pressure to carry out a new feat of creative accounting to meet Greek Finance Minister Yanis Varoufakis’s request for renegotiation of €6.7 billion in ECB bonds due to mature in July and August. In a round of interviews, Varoufakis has pledged that his country will make repaying its debts to the International Monetary Fund its main priority. About €2 billion needs to be repaid to the Fund this month. But the Greek minister has drawn a strong distinction with the ECB, making it likely that the central bank may have to bring in further conditionality into its traditional insistence that it should always be treated as a preferred creditor on a par with the IMF. Leading European politicians have long claimed that the ECB will have to show flexibility in rolling over some of the total of €30 billion in Greek bonds it still holds in its portfolio, resulting from its efforts started in 2010 to prop up weaker members of the euro EURUSD, -0.42% Further bruising tussles between Greece and its creditor look inevitable in view of the deliberate ambiguity the Greek government built into the provisional agreement with creditors clinched last month after several finance minister sessions in Brussels. Speaking in Berlin on Monday, German Chancellor Angela Merkel said Greece would have to make its reform proposals more specific and agree to the program with the “three institutions” (formerly called “the troika”) of the European Commission, the ECB and the IMF. Similarly, Jeroen Dijsselbloem, the Dutch finance minister who heads the euro finance ministers’ group, says Greece must immediately start adopting the creditors’ list of reforms, as a condition for gaining access to emergency funds needed to meet March cash deadlines. There is little doubt that, provided Europe’s main capitals give political backing to the still-ambivalent Greek reform approach, the ECB will bend to the politicians’ will — even though it will face further charges of a watering down of its constitutional independence. The Greek government is calling for concessions such as the lifting of a €15 billion ceiling on the issue of short-term treasury bills. Given the overriding political resolve to keep Greece in the eurozone, above all because the precarious geopolitics of southeast Europe, some form of compromise is likely here, too. Over the past month, as a result of fresh worries surrounding Greece’s membership in the euro, the so-called Target2 balances indicating stress in economic and monetary union have started to emit warning signals. Over the past two years, as a result of a general diminution of tension, these balances have been shrinking. But in January the Target2 balances, measuring asset and liabilities of the individual Eurosystem central banks vis-a-vis the European Central Bank, showed renewed divergence, The Bundesbank reported a €54 billion increase in end-January Target2 assets to €515 billlon. Greece has stated its liabilities increased €26.7 billion to €76 billion that month. The volatility of these balances is likely to rise further in coming months, according to Frank Westermann, professor of economics and director of the Institute of Empirical Economic Research at Osnabrück University, who collates these figures in Euro Crisis Monitor. One reason for the improvement in the balances was that in December 2011 the ECB calmed financial markets by issuing two “long term refinancing operations” (LTROs) available to banks for a three-year period, at low interest rates and with reduced collateral standards. This instrument caused a substantial increase in Target2 balances, as it opened a door for capital flight. The banks were able to use risky bonds as collateral for fresh money and transfer this money to safer countries, Westermann says. Three years later, a substantial part of these three-year loans have been repaid. This month sees the deadline for the last tranche of loans. This forms one reason why Target2 balances could fall substantially— in particular in countries that made strong use of LTROs, such as Italy and Spain. Yet Greek uncertainty may drive Target2 balances higher. Greece’s Target2 liabilities fell from a peak €109 billion two years ago to only €30 billion last summer, a technical reaction to Athens’ bailout-packages. The apparent improvement in Greek balances was almost exactly aligned to inflows from the rescue accords. So it is no surprise that, in the weeks before the end-January Greek election, Target-2 balances started to worsen again — and could show further deterioration in the months ahead. David Marsh