Greece may well live to default another day


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After protracted negotiations, the Greek government has agreed on a new austerity package. The resulting bond exchange is likely to proceed with bond holders suffering losses of more than 70 to 75 per cent.

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Hey there, time traveller!
This article was published 28/02/2012 (4107 days ago), so information in it may no longer be current.

After protracted negotiations, the Greek government has agreed on a new austerity package. The resulting bond exchange is likely to proceed with bond holders suffering losses of more than 70 to 75 per cent.

The Troika — the European Union (EU), European Central Bank (ECB), and International Monetary Fund (IMF) — needs to reduce Greek debt to a “sustainable” 120 per cent of gross domestic product by 2020. The bond deal and the latest budget cuts are designed to achieve this, paving the way for a second financing package that would enable Greece to repay a 14.5-billion-euro bond on March 20.

But even the greater austerity and larger losses to lenders will probably leave Greek debt above the target level, requiring delicate financial engineering to at least cosmetically reach the target. In the end, even with a dollop of wishful thinking and economic gymnastics, the projected debt figure came in at 120.5 per cent in 2020, based on extremely courageous assumptions of growth.

The 120 per cent level is largely meaningless, being a political construct designed to avoid drawing unwelcome attention to Italy, whose debt is also around this level.

There is no certainty the agreement reached can be implemented. The deeper losses will increase resistance to the deal, especially from hedge funds that may prefer to take their chances in a default.

One option is to unilaterally insert collective action clauses (CACs) into existing bond contracts, allowing a super majority of lenders to bind the minority. A complicating factor is the ECB’s refusal to take losses. With direct holdings of Greek bonds of 40 billion euros, as well as additional loans to banks secured by Greek bonds, the ECB’s capital of five billion euros (scheduled to increase to 10 billion euros) is insufficient to absorb losses. As the CAC would force the ECB to share in losses, a special arrangement will exempt it from the effects of any CAC to the further detriment of already resistant private lenders.

Any agreement is also likely to face legal challenges from lenders, which would complicate proceedings. A group of hedge funds has even threatened to take action in the European Court of Human Rights, alleging Greece has violated bondholders’ “rights.”

Another complication is the extremely tight timetable that must be followed to ensure the arrangements are implemented in time. Greece must undertake certain actions to qualify for the funding. Parliaments in eurozone members must approve the package. The European Financial Stability Facility (EFSF), the current main European bailout facility, must raise around 70 billion euros to finance the bond exchange. Of course, the EFSF is guaranteed around 30 per cent by Spain and Italy! There is little margin for error.

This agreement is unlikely to be the definitive resolution everyone seeks. Greece has consistently failed to meet economic forecasts.

Despite measures by the Greek government, debt continues to rise. According to the EU statistics office, Greece’s debt reached 159.1 per cent of GDP in the third quarter of 2011, up from 138.8 per cent a year earlier and 154.7 per cent in the previous quarter.

Greece may get through the March maturity, but the arbitrary 120 per cent debt-to-GDP ratio — the best case under the plan — is unsustainable, even in the unlikely case it is met. The Greek economy, which has been in recession for years, shrank by seven per cent in the latter part of 2011. Budget revenues for January 2012 fell seven per cent from the same time last year, a fall of one billion euros. This compares to a budget target of an 8.9 per cent annual increase. Value-added tax receipts decreased by 18.7 per cent in the same period versus January 2011.

Greece’s financial position will deteriorate and it will miss key milestones — debt levels, budget deficits, asset sales and structural reforms.

In the end, Greece may live to default another day. History suggests a write-down of debt for distressed borrowers is frequently followed by others.

With Greece increasingly doomed, the real significance of the negotiations is they provide a template for future European sovereign restructurings. No one buys the oft-stated European leaders’ position Greece’s position is unique or exceptional. Portugal is first in the line of fire, with the Irish, Spanish and Italians watching anxiously.

Satyajit Das is the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011), and a consultant to Jory Capital.

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