Today (3rd June) the famous troika inspectors are making public their report on the progress of Greece and its adherence/compliance to the memorandum singed. It is no secret that the Greeks have not exactly succeeded in meeting the targets set and in some areas they are very far behind. For example, income from taxes missed the target as the recession bites and tax administration and collection reforms have not as yet kicked in. Privatization of state assets and companies has not even started despite their promises mainly because the government is unwilling to “restructure” or downsize their own-controlled unions and supported. The current government (Socialist PASOK) is the party that spearheaded the expansion of the state sector the past 30y (22 out of 30y) and find it difficult to kill their own brainchild. Despite what they claim when they are facing EU officials the main opposition does not come from the conservatives but from inside their own party officials and even ministers. Yet they managed a 5% reduction of debt in 1y and have timidly started some reforms to liberalise the economy.
Where does this lead us? Default? Restructuring or some sort of re-profiling? Looking at the debt numbers it is clear that the Greek debt is unsustainable. The current state of the Greek economy simply cannot generate enough revenues to pay the interest, never mind the principle. The program of the IMF/EU/ECB was from the start a utopian one. One cannot turn an economy by 180 degrees in two years or expect them to make more than 15% fiscal adjustment in 3 years under the current economic environment. Their decision was a political one and not an economic one, in the same way it was a political decision to accept Greece, Italy and Belgium into the Euro despite not meeting the criteria.
Now all of sudden everyone is talking of default and restructuring.
Default:
Greece would find it very difficult to declare a moratorium as they are not running primary surpluses. In other words, if they decide to stop paying their debt they are still short cash to pay pensions and salaries. But let’s say they do, what are the consequences? Well, bondholders would have to start writing their debt down. Most if not all the banks who hold Greek debt have moved it to the Banking book (Hold to Maturity) in order to shield it from the famous banking stress tests (they do not stress test the banking book). The GGB would stop being eligible collateral with the ECB. This would immediately mean bankruptcy for the Greek banks unless the Bank of Greece engages in ELA (like Ireland) on a massive scale. But the ELA is guaranteed by the state, in this case Greece which has declared bankruptcy….It all becomes very surreal. Many European banks and pension funds would suffer now real losses as opposed to mark to market losses and their local politicians would need to come to their rescue. Politicians prefer to kick the can down the road rather than dealing with them. Then we have the “small” matter of the ECB. The ECB took enormous risk by buying 45bln of Greek debt. They bended their rules in order to save the EU as the politicians argued. The ECB in essence has become the “Bad Bank” of Europe. They would need to raise billions of capital from their shareholders (the National Central Banks, including Greece) to cover their losses as they cannot print money (Maastricht treaty). Next, come the Irish and the Portuguese . They have every right to question the ethics of Greece escaping through default while they go through painful fiscal consolidation. They may be tempted to follow Greece or at least renegotiate their packages. Default also removes many levers that the EU has on Greece to push the reforms and may need to deal now with genuine civil unrest both in the peripheral countries but also in their home. You simply don’t give 110bln (55 have been disbursed so far) only to find out a year later that you are not getting them back any time soon.
Finally, there is the legal matter. Default and restructuring with a haircut is a messy business. The majority of the GGB are under Greek law (90%) which basically gives them a free hand to do what they want.
I am not mentioning the CDS as it is a minor problem. According to the latest figures there are about 6bln outstanding Greek CDS.
Reprofiling:
Recently, many EU officials (of greater or lesser importance) have talked about bondholders volunteering to extend their holdings. How would this work? The EU politicians pressure their banks and Insurances and pension funds to extend the holding period of their GGB after maturity with the same or better terms. This may involve credit enhancements or coupon increases. Apart from the fact that the ECB ruled this out (for their own reasons and agenda), this assumes that Greece has a short term liquidity problem and that their debt is otherwise sustainable. The ones that chose not to follow this re-profiling according to the Vienna principles get their money back while the re-profilers get more GGBs. If there is to be a restructuring in the future they would suffer even bigger haircuts as the IMF would get their money no matter what. But let’s assume that the Greek government pressures the Greek banks to extend their holdings (banks 45bln, Greek funds 30bln). Is this in their best interests? Not really. You need to have a healthy banking system to drive Greece out of the mess not just spreading the infection.
Trading GGB
Most market participants look at the price the Greek bonds are trading and they infer a high probability of default. Is this correct? Does the price of the GGB really reflect the true market? There is increasing evidence that this is not the case. Most of the GGB are not available for trading. Banks have moved them to the Banking book (to avoid stress testing) and marked them at par. As a result, selling them at the current screen price would mean taking a loss. This is a negative feedback loop. Only small sizes come out for trading by scared investors. The big ones are holding on to their GGBs. By depriving the market of liquidity they are pushing the prices down rather than up. This is the opposite of what one would expect in a normal market.
Future:
The most likely outcome in the next few days is that Greece gets the 5th instalment and that they also negotiate a further rescue package to carry them through 2013 possibly longer. In return, the Greeks would have to accept some sort of long term “supervision” and loss of fiscal sovereignty. This may not be as bad as it sounds. The EU needs to move to a closer Economic union (fiscal) if it is to survive the crisis and Greece may be the spark of this. The head of the ECB has already spoken in favour of a European Finance minster, and the French are pushing for “Economic Government”. There is only one problem. “No taxation without representation”. The EU is still a very undemocratic venture. The European parliament does not play any significant decision making role and there is a democratic deficit. If Greece is to become the first Fiscally consolidated European country, Europe would need to reform their democratic and accountability institutions and processes.
No comments:
Post a Comment