Greece: end of chapter one but the fraud continues
1. The rescue
As indicated in a recent article on my blog Thursday April 8th, the end of the game was
to be decided within a week. On April 11th, after spreads on Greek debt had soared
and the first signs emerged of a possible run on its banks, the panic mode button was
on within the Euro-zone.
Sunday's announcement of details of a Greek bailout by Euro-zone finance ministers
calmed markets: interest rates and CDS spreads on Greek debt immediately plunged, the
market being convinced Greece will not be let down. The rescue package is made
up of €30 billion in loans from Euro-zone governments at an interest rate of 5% (below the
7.3% market rate pre-agreement), and up to €15 billion from the International Monetary
Fund. The Euro-zone charge reflects an average market rate over a period of time before
market jitters drove up Greece's borrowing costs. Obviously, this is a subsidy to Greece
(contrary to European treaties), but never mind, France got its way (Greece owes EUR
252.8 billion to European banks and France is the happy winner) …
Under the euro zone's rescue formula, Germany would have to supply about €8.4 billion of
the loans for Greece - equivalent to more than €100 for every person in Germany. This
assumes that it will not be successfully challenged before German courts.
2. Why this rescue package was so urgent?
By April 16th, Greece had to refinance 26- and 52-week government bills, and
it was clear that either it could not raise it in the markets, even at punishing
rates (7%+). This was seen as politically unacceptable by other euro-zone countries
(France being at the forefront) and triggering a spilling effect beyond Greece.
The trick worked: Tuesday, Greece raised 1.56 billion euros in a heavily oversubscribed
auction for 26- and 52-week government bonds that effectively carries a European Union
guarantee. Whilst rates were below the ones prevailing a couple of days before
the weekend agreement, yields were still high at 4.85% for the 52-week bill and
4.55% for the 26-week bills compared to respectively 2.2% and 1.38% on January 12.
In addition, yields on debt with maturities of two or more years were still at least 6 percent
in Tuesday trading, meaning the government will have to pay a high price as it
seeks to refinance EUR 40 billion more in debt this year.
3. Will it be enough?
The combined IMF and euro-zone rescue package will be enough to cover
Greece remaining debt funding requirement for the rest of the year. European
countries concluded, some reluctantly, that continuing to support Greece is less costly
than letting the country go under. They bought (very little) time, nothing more.
The breathing space created by the implicit bailout of Greece seems to be
running out of steam already. According to Market News International, Friday,
Greece 10-year spreads were widening out and trading at +408bps vs +401 bp
Thursday. This yield spread has widened by around 85 bp since positive reaction by
financial markets to Sunday's Euro-zone announcement. The details of exactly how the
EMU and IMF portions of the plan would mesh together have been vague to non-existent.
In addition, conflicting comments from EU members, reports of potential delays and
legislative requirements needed to trigger the EUR 30 billion worth of loans put on offer
by EMU governments, have pushed spreads wider as Athens now looks like it won't issue
it's dollar-denominated bond after it begins its roadshow in the United States on April 20.
Let’s have a look at the 2010 Greek State Budget.
41.5% of ordinary budget revenues come from borrowing and 62.5% of
investment financing. The national debt as of 31/12/2009 stood at EUR 298.5
billion and a total sovereign exposure of EUR 324.3 billion if EUR 25.8 billion
state guarantees are added. The Stability and Growth Program is projecting EUR 24
billion new borrowings to plug the deficit (EUR 39 billion in 2009) – EUR 5.2 billion
decrease coming from 2 non-recurring items.
These few numbers show the dead end in which the Greece is.
Interest payments represent roughly 5.4% of GDP; in fact this number will be higher since
interest rates on the Greek debt have dramatically increased since the budget was
The sheer size of the problem facing Greece, beyond the burden of debt, finds
its source in generous retirement and social benefit unfinanced by an
uncompetitive economy: altogether they represent EUR 28.7 billion, i.e. 1/3 of the
budget. Furthermore, from what I read (is it part of a Greek marketing campaign?), tax
collection is very lax, and this could bring EUR 10 billion in state revenues if properly
Greece is facing insolvency with interest payments at 5% GDP, 113% Debt/GDP and
12.7% public deficit in 2009, to be reduced to 8.7% en 2010. The Greek government has
based its plans to shrink the budget deficit on a modest economic downturn of 0.3% this
year (nobody with common sense can believe this). UBS forecasts a plunge in GDP of 5%
this year and next as cuts in public sector wages and other austerity measures feed through
into the broader economy. If so, Greece could become caught in a vicious circle where
declining output undercuts attempts to reduce the ratio of borrowing to GDP. The debt
burden would increase at the same time the government’s ability to pay was declining.
Half of the improvement during Q1 2010 budget deficit is coming from the reduction in
the Public Investment Program ("PIP"), which is 10% of the overall budget: scope to find
additional cuts in coming quarters from this side is therefore limited particularly as PIP is
expected to increase this year.
According the The Economist: “Even with a fiscal adjustment worth 10% of GDP over the
next five years, Greece will either need more official loans for longer than the
current rescue package promises or will have to “restructure” its debts ... Even
on optimistic assumptions, we reckon Greece will need €67 billion or more of long-term
official loans in the next few years. Its debt burden will peak at 150% of GDP in
Ultimately, Greece’s fate rests on the ability of Mr. Papandreou and his
government to create a more competitive economy. However, as a euro member,
Greece cannot take the traditional route to competitiveness in world markets and devalue
its currency to cut the price of its exports; it can only play on costs, i.e. mainly wages and
other social/retirement benefits: this will be long and very painful, if successful, whilst
keeping the euro.
4. The core of the problem: no common vision of Europe
Euro-zone governments hope that the rescue package will never be used and
will act as catalyst for investors to continue financing Greece at not too punishing rates.
Whilst it will work at least for short term financings -hence the success of the 26
and 52 weeks bills issued last week- I have doubts beyond.
Greece cannot reach a 3% budget deficit by 2012 (or numbers will be fudged, tricks
found at the European level to save the Saint Graal of Euro-zone). European countries
cannot continue financing/backstopping Greece for ever, particularly when many
have problems of their own and the Euro-zone economy will continue to underperform the
rest of the world.
This bailout does not address the real issue: the gap of competitiveness
between economies of the Euro-zone, the lack of control of statistics provided
by countries (Bulgaria recently announced that it lied on its 2009 deficit and therefore
was postponing its application to the euro), and the absence of social and fiscal
In fact there is no common vision of Europe. Germany has for 40 years financed the
Common Agricultural Policy (+/- 50% of the EU budget), Germany paid its reunification
without the help of anybody, Germany has maintained its competitiveness and is the world
second exporter after China. So you get 4 Europe:
• Germany and the likes (budget discipline and competitiveness)
• France and the Club Med countries (slow reforms, budget profligacy)
• Non Euro-zone European countries pre-Nice Treaty (UK for example)
• Post-Nice Treaty new entrants (ex Eastern European block countries)
Many of these countries joined the EU or the Euro-zone with different
motives: for example, former soviet bloc countries to stir away from their former mentor
and take advantage of generous funding, Club Med countries to avoid fiscal discipline and
increase competitiveness by hiding behind the euro that resulted in incredibly low cost of
financing of public deficits.
None are either at the same stage of development, fiscal discipline and
competitiveness or share the same objective. The one-fits-all is at best a fallacy,
at worst a fraud, without fiscal coordination, control and enforcement. It will
not last for ever if reality is not dealt with by European governments.
The past month of Greece-related negotiations has illustrated that the institutional
framework of the Maastricht Treaty and the Stability and Growth Pact has
failed to enforce better fiscal coordination. This will need to be addressed via a
significantly more binding Stability and Growth Pact. However, as noted in my letter to the
President of the Eurogroup, improved control and enforcement tools remain
conceptually incompatible with fiscal sovereignty.
Overall, the fiscal situation remains highly uncertain. Greece’s problems could drag well
into 2011, when the next heavy maturity schedule is due early in the year (~EUR 28
billion). So far, very little evidence on the success of the fiscal consolidation program has
become available. Debt sustainability remains another issue that could become
Greece will not default in 2010 and probably not until mid-2012, IF Germany involvement
is not successfully challenged before courts. For the non-hart fainted fixed income yield
seekers, invest in short dated Greek debt, particularly at time of stress when spreads
Personally, I prefer large companies with sustainable dividend payment to get yield.
NB: THIS ARTICLE WAS WRITTEN FRIDAY AND WAS NOT POSTED UNTIL TODAY
DUE TO INTERNET CONNEXION PROBLEMS
WSJ: Political Risk Looms for Merkel
WSJ: Only Debt Restructuring Can Save Greece
WSJ: Who Pays What for Greece
NYT: Some Respite for Greece in Successful Debt Sale
NYT: Some Respite for Greece in Successful Debt Sale
Greek Debt Office
Goldman Sachs: The Global FX Monthly Analyst – April 2010
The Economist: Three years to save the euro