20 April 2010

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 established. 

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 addressed.
Greece is facing insolvency with interest payments at 5% GDP, 113% Debt/GDP and 12.9% 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 [emphasis mine]:
"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 2014."
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 convergence.
In fact there is no common vision of Europe. 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 their public deficits.
None of these groups 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. Germans are going to be fed up to finance Europe without any return.
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 increasingly important.
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 increase.
Personally, I prefer large companies with sustainable dividend payment to get yield.
Goldman Sachs: The Global FX Monthly Analyst – April 2010

The Economist: Three years to save the euro