We met last week with a savvy German investor, one who unlike many of his peers, is well aware of the German bank exposure to Greek and other Club Med debt. He argued that Greece will default within six months.
That view might have seemed extreme a week ago, but as Wolfgang Munchau points out today in the Financial Times, the markets also appear not to be buying what the EU and Greece are selling:
The European Union finally agrees a bail-out, and the much-predicted rally of Greek bonds turns into a rout. A week later, spreads on Greek bonds had reached their highest levels since the outbreak of the crisis. The financial markets have recognised that, bail-out or no bail-out, Greece is in effect broke.
Yves here. Munchau is at least more optimistic than my German contact, since Munchau believes Greece will not default in 2010. But the only difference in their views is of the timing, not the eventual outcome. The austerity programs demanded of Greece are by some measures more than twice as severe as those imposed on Argentina at the turn of this century. And remember, Argentina defaulted:
To avoid long-run insolvency, Greece will need to find a way to stabilise the debt-to-GDP ratio. This would in turn require a multi-annual deficit reduction plan and a programme of structural reforms to raise the potential growth rate. The Greek government has so far presented a one-year plan to cut the deficit from 13 per cent of GDP to about 8.5 per cent. While this sounds ambitious, it is not very credible, as it is based heavily on tax increases, with no structural reforms.
But even if the Greek government were to present a credible long-term stability plan, the risk of default would remain high. This means that some form of debt restructuring is unavoidable. Restructuring is a form of default, except that it is by agreement. It could imply a haircut – an agreed reduction in the value of the outstanding cashflows for bond holders. The Brady bonds of the late 1980s, named after Nicholas Brady, a former US Treasury secretary, worked on a similar principle. An alternative to restructuring would be a debt rescheduling, whereby short and medium-term debt is converted into long-term debt. This would push the significant debt rollover costs to well beyond the adjustment period.
Ambrose Evans-Pritchard turns to Portugal, and argues that while it is in better shape than Greece, it too is at risk, and were Portugal to suffer funding problems too, the eurozone might not survive the test:
The long-drawn saga in Athens can perhaps be deemed a case apart. Greece lied. Its budget deficit was egregious at 16pc of GDP last year on a cash basis. It wasted its EMU windfall, the final chance to bring public debt back from the brink of a compound spiral….
Brussels admitted last week that Portugal’s external accounts have switched from credit in the mid-1990s to a deficit of 109pc of GDP. This has been caused by the incentive structures of EMU itself. “The more broadened access to credit induced a significant reduction in the saving rate, while consumption kept growing faster than GDP. This development led to an increase in Portuguese indebtedness,” it said.
The IMF’s January report said “The large fiscal and external imbalances that arose from the boom in the run-up to adoption of the euro have not been unwound, resulting in the economy becoming heavily indebted and growing banking system vulnerabilities. The longer the imbalance persists, the greater the risk the adjustment will be sudden and disruptive.” The IMF noted the “heavy reliance” of banks on foreign wholesale funding, equal to 40pc of total assets….
Yes, Portugal’s public debt will be 86pc of GDP this year against 124pc for Greece (EC estimates). That is small comfort. Giles Moec from Deutsche Bank said Portugal’s private debt reached 239pc in 2008: Greece was 123pc. Total debt levels matter. The last two years have taught us that private excess lands on the taxpayer one way or another. For Portugal, the figure is now is in the danger zone above 300pc….
Portugal does not face an imminent funding crisis. If Europe’s economy grows briskly, it may be enough to lift the country off the reefs. But one thing seems sure: Germany is not going to bail out any more countries, and the IMF is too small to cover.