Tuesday, May 10, 2011

Greece at the doorstep of default?

It was an year ago when Greece accepted a 110 billion Euro EC/IMF bailout that was expected to restore market confidence and set the country back on the recovery path. So what is the verdict after a year?

For a start, Greece’s economy shrank 6.6% in 2010, far more than the 1.9% decline in 2009, thereby amplifying the debt-GDP ratio. The yield on 10 year Greek government bonds have rocketed to 15.5% from just over 7% in early May 2010.

The cost of insuring 5 year bonds have nearly tripled from just above 500 basis points to 1400 basis points.

The eagerly anticipated "confidence fairy" expected from the bailout announcement also appears to have eluded the peripheral economies. The peripheral European bond spreads (over German bonds) have surged continuously and those of Greece, Ireland, and Portugal have all set record highs.

Apart from Greece, the CDS spread on Portuguese and Irish debt too have widened since.

The yelds on three-year bonds have surged spectacularly across all the three major peripheral economies. It stands at an exorbitant 23% for Greece.

These strong contra-indications of market scepticism is despite the fact that the bailout has been going on below the surface. The European Central Bank has been lending money to Greek banks, accepting Greek bonds as collateral on loans to other banks, and even buying bonds, all in the hope of buying time so that market confidence would be restored and the economy will be back on recovery path with time.

However, as I have blogged earlier, this arguement is based on the assumption that Greece and others face a liquidity crisis, not a solvency problem. If, as is increasingly being felt, this diagnosis is wrong and there is a solvency problem, then a sovereign default or atleast restructuring of debt, with creditors taking haircuts, is the only way out. Delaying it will have the danger of transmitting the risks to the other vulnerable economies, especially Spain and Italy. Further, uncertainty on sovereign debt also increases market volatility, thereby affecting the economy itself in many ways.

In any case, it does look increasingly likely that Greece will be the biggest sovereign default or atleast restructuring since Argentina's $81.8 bn sovereign default of December 2001. For the record, it has been locked out of international capital markets ever since. The rating agencies too appear to think the same.

Update 1 (14/5/2011)

Excellent NYT editorial highlighting the challenge facing EC on Greece. With no private lender wanting to finance its debts and more than $400 bn in debts coming due for repayment by next year, further assistance to both private and public lenders from EC is inevitable. And this has to be followed up with restructuring of these massive debts. The editorial writes about the prospects,

"Greece’s economy shrank 4.5 percent last year and is projected to fall an additional 3 percent this year. Average salaries are down roughly 10 percent. Those grim numbers have translated into shrinking tax revenues and bigger budget deficits. Greece’s national debt, now just over 140 percent of gross domestic product, is on track to rise to 160 percent next year, and keep rising."

The prescription could not have been more appropriate,

"No serious banker any longer believes Greece can pay all that it owes on time. Greece got itself into this mess. But Europe will have to help it get out. It will become even harder the longer Europe waits and pretends."

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