Greece: Kicking the can down the road once more
November 30, 2012
In keeping with what has become a somewhat common practice, Eurozone finance ministers in a late-night marathon session earlier this week finally agreed to schedule the release of 44 billion euros from GreeceaEUR(TM)s second bail-out program. Finance ministers were able to end an impasse with the IMF requiring Greek authorities to shrink government debt below 124 percent of GDP by 2020. However, a host of challenges will need to be overcome in order to reach the debt reduction objective.

The agreement includes the following phased debt-service relief measures:

• Reduction in interest rates on bilateral loans owed to other Eurozone governments as well as a 15-year extension of maturities, which could save Greece approximately 4.2 billion euros by 2020.

• Profits on ECB holdings of Greek bonds will be returned to Greece through individual country authorities, resulting in an estimated savings of 11 billion euros.

• 10-year interest payment moratorium on EFSF loans, which could generate liquidity savings over the period of nearly 44 billion euros, according to Citi Research.

• 10 basis point cut in fees on EFSF loans, providing about 1.7 billion euros in relief.

• 15-year extension of the maturity of EFSF loans

Another major element of the deal and one that will result in almost immediate debt reduction is GreeceaEUR(TM)s commitment to buy back its privately-held debt at prices no higher than those at the market close on Friday, November 23. The buyback is scheduled to take place no later than December 13. As of now, it is not clear where buyback money will come from or how much debt reduction might be achieved. Greek Finance Minister Stournaras has suggested that buyback funding will come from new EFSF loans. Estimates from various sources indicate 10 billion euros or more could be committed to repurchase debt. On the basis of the floor estimate, net debt relief could approach 24 billion euros by 2020, equivalent to roughly 10 percent of projected GDP.

Although this agreement could offer the Greek authorities an opportunity to break out of the downward economic and financial spiral, this outcome is far from assured. In particular, the proposed debt buyback from private holders might not lure enough participants to have a meaningful impact. Already Greek banks, which hold about 15 billion euros of the roughly 65 billion euros of privately-held outstanding Greek bonds, claim they are unable to take part. The buyback, they assert, would have substantial negative repercussions on their capital position. Hedge funds, which possess an estimated 20-25 billion euros of bonds, are likely to balk at the reported price being offered. As pointed out by one observer, why should a hedge fund manager sell his/her bonds at 35 cents on the euro, when Eurozone finance ministers are intimating that the Greek situation is poised to be much better in the future.

If the buyback fails, this could create immediate problems for the IMF, which is responsible for approximately one-fifth of the nearly 250 billion euros in assistance that has so far been promised to Greece. Christine Lagarde, the IMFaEUR(TM)s managing director, has made it clear that she will not agree to release the next tranche of IMF funds until satisfactory results from the buyback are achieved. A shortfall in the buyback would rekindle IMF concerns about debt sustainability and necessitate a scramble to find other ways to close the funding gap. Meanwhile, some market participants are already criticizing the planned buyback. They contend the money could be better spent elsewhere as the targeted debt has low interest payments and no principal due for a decade.

Beyond the immediate future, it is not clear that the Greek authorities would be able to adhere to the assumptions that underpin the adjustment program. Achieving and then maintaining a primary surplus of 4.5 percent of GDP will be difficult as will be ratcheting up nominal GDP growth to more than 4 percent per annum. In any event, this weekaEUR(TM)s deal on Greek debt should appreciably reduce the risk of a possible Greek exit from the Eurozone during the next year. However, there is still a high probability that Greece will need additional large-scale debt reduction, especially if the revamped adjustment program shows signs of unraveling. In the meantime, we probably will need to turn our attention soon to Cyprus given the alarming deterioration in the countryaEUR(TM)s financial position, particularly among its banks.