Tuesday, June 14, 2011

The Hellenic sovereign default draws closer

The inevitable sovereign default climax to the Hellenic tragedy appears to get closer with the downgrading of Greek debt by Standard & Poor to CCC. The three-notch downgrade makes Greece’s debt the lowest-rated in the world by S&P and Greece the lowest rated country in the world. This follows Moody’s Investors Service lowering Greece’s credit rating by three notches to Caa1.

Underlining this market belief about a sovereign debt default being only a matter of time, with 85% of respondents in a Global Investors Poll predicting a Greek default. Most investors also feel Ireland, with fiscal deficit at a staggering 32% of GDP in 2010, too will default and atleast one nation will leave the Euro by 2016.

Anticipating this, the Greek CDS spreads and 10 year bond yields have gone up. The CDS spread is close to 1600 points.

The benchmark 10 year government bond yield has touched 17%, shooting up from 13% at the begining of May. Two year bonds are at a staggering 26%.

On the macroeconomic front, Greece has an unemployment rate of 16.2% and fiscal deficit was 10.4% in 2010 and is set to rise. It has financing needs of close to 160 billion euros ($229 billion) through 2014. The government is struggling to get through the latest round of fiscal austerity measures.

It is amazing that Euro area policy makers have let things drift this far. For nearly a year now, even when the Greek bailout was engineered, it was amply clear that without significant restructuring, a sovereign default was only a matter of time. However, on ideological grounds and to avoid causing losses to its own banks (who have massive exposures in the peripheral economies), Germany and other major economies opposed all forms of debt restructuring. It was thought that austerity measures in these economies will bring back macroeconomic stability, increase revenues, and help them repay their debts. The bailouts, it was argued, will help reschedule the loans and insulate Greece from the credit markets for some time.

A year on, things have obviously got worse. The costs inflicted far outweigh the possible benefits of an early restructuring. The Greek economy has contracted far more and debt position worsened, not to speak of the damaging impact on Eurozone economies. A quick and decisive debt restructuring, while temporarily painful, would have avoided this prolonged hemorrhage.

Update 1 (17/6/2011)

Times writes about the steep increase in Greek CDS spreads, "An investor now has to pay about $2 million annually to insure $10 million of Greek debt over five years, compared with about $50,000 on the same amount of United States government debt".

Update 2 (6/7/2011)

Moody’s cut its rating on Portugal’s long-term government bonds to Ba2 from Baa1 or junk status and said the outlook was negative, hinting at more downgrades. Even though Portugal negotiated a $116 billion rescue package in May, the ratings agency cited the risk that the country would need a second bailout before it could raise funds in the bond markets again and that private sector lenders would have to share the pain. It expressed scepticism at the country's ability to meet the challenges it faces in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.

The downgrade came a month after a general election in Portugal in which voters unseated the Socialist government of José Sócrates. Since then, the new center-right coalition government, led by the Social Democrats and Prime Minister Pedro Passos Coelho, have pushed ahead with austerity measures and other reforms pledged by Portugal in return for its bailout.

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