Yesterday in a teleconference between 16 Euro zone finance ministers finally we saw some actual plans for a rescue scheme for Greece. I had begun to suspect something might be afoot simply by the fact that so many Euro zone figures were in effect giving up part of their weekend and their sunday lunch! It followed upon a Friday that had been very volatile as rumours of a rescue scheme had begun to circle the markets (initially of course this would have been met with dismay and derision as we have had so many of these) and finally Euro zone officials had begun to talk about it. Adding to the volatility on Friday was the announcement that the ratings agency Fitch had downgraded Greece by two notches, from BBB+ to BBB-.
Significance of the move by Fitch
The BBB- rating is significant, as this is the lowest rating that qualifies as an investment grade bond. Any further downgrade would mean Greece losing its investment grade status with Fitch. This has implications on several fronts. Firstly any further downgrade (if followed by the other ratings agencies) would mean that many investment funds would no longer be able to invest in Greek government bonds as they would have fallen to “junk” status. Also the rules for being able to place collateral at the European Central Bank require the collateral to be of at least BBB- status and Greece is now right on that threshold if the other ratings agencies follow suit. It is also true that Fitch left its negative status on Greece i.e the next move in its view is more likely to be down than up.
For once a ratings agency has tried to be more proactive. However it is still true that Greek government bond yields were of “junk” levels before Fitch made its move on Friday. So even in this instance it has followed and not led events. The other two ratings agencies have not responded at all yet. It still disappoints me that ratings agencies have emerged from a crisis which they helped create possibly even stronger that before. I would like to repeat my belief that we need a new system as plainly using them is flawed.
It is possible that Fitch’s move was part of the factors that has made Europe improve its previous detail-lite plans. Personally I feel they have proved to be so slow on their feet that something was probably in progress anyway,seeing as many statements from politicians are palpably untrue even if they told us would we believe them?
In a febrile and volatile atmosphere on Friday Greek ten-year government bond yields had at first risen then fallen back as rumours of (another) rescue plan grew and finally rose again as Fitch downgraded Greece as described above. This sort of price action following on from earlier in the week is likely to have been a trigger for the Euro zone to get its act together. If it was not it should have been…
What is it?
Europe has promised a total of 30 billion Euro’s of bilateral loans to Greece should she request them. These loans will be for a three-year term and are in effect available for 2010. The interest rate will be around 5% and will be fixed.One interesting development is that there have not emerged any further conditions so far on Greece in return for the money.
Contributions to any rescue would be proportional to each Euro zone members capital commitments to the European Central Bank, leaving Germany with the largest share. Putting the loan in economic terms it represents just over 0.3% of the Euro zones Gross Domestic Product .
Also there is expected to be assistance form the International Monetary Fund (IMF) but this is so far only talk. For example there is talk of the aid being 15 billion Euros or its equivalent when I believe the IMF is more likely to cap itself at around 10 billion Euros. There is much less detail on this and all we have is some public talk from the IMF’s President. I am expecting more clarification today. If there were to be further conditions on Greece it would be politically convenient to let the IMF impose them…
Whilst this is an improvement on previous plans in terms of the fact that this time the plan is more fleshed out some ambiguity remains. For example an interest rate of around 5% (calculations have settled on 4.76% and 5.01% but Europe should have specified it and in case you are wondering the odd-looking numbers start from the IMF’s SDR rate which is 0.26%). What role the IMF will play is simply undefined.
The lower interest rate of around 5% is an improvement on the German suggestion of “market rates” as for example Greek two-year government bond yields closed at 7.45% on Friday. As to why Greece would ever take money at the same rate as it could get funding from the markets rather escapes me unless of course it was never intended to work and was an empty promise.
If I had been responsible for this the announcement it would have come with an agreement that Greece was initially taking up enough of the money to get her to the end of May. This would have given markets time to calm down. It would also have got Greece through the most difficult time of the year and then she might then have been able to fund herself at the rate of 2 billion Euros a month that will be required for the rest of the year. In effect the liquidity problem would have been solved for 2010 giving Greece some badly needed time for the austerity programme to settle in and make some progress.
Profits for Berlin
If the plan is fully activated then Germany will make a loan to Greece of around 8.3 billion Euros on which Greece will borrow at 5%. However if we look at the German government bond market depending on what term she borrows the money at it is quite conceivable that Germany can borrow the money at 2% (even her 5 year bonds only yield 2.14% and shorter maturities are cheaper). So each year under the full-sized loan Germany makes just under 250 million Euros so over a 3 year term she makes 750 million Euros. Nice work if you can get it perhaps but not exactly the sort of news I would want to be explaining on a street corner in Athens!
Germany is the biggest beneficiary from this but there will be others.
German Constitutional Court
The resistance of German Chancellor Angela Merkel over such a sustained period must mean that she was afraid of such a deal going to the German Constitutional Court. Perhaps finally she feels that she has found a way around it. But sooner or later and probably sooner this deal will be sent there. If the German government was sure it would win here we would have had an agreement a while ago. One of the worst implications of this is that it probably will not go there now as there is no action until Greece asks for it but as soon as she does imagine the uncertainty that would be caused by this court examining the plan. If it was to rule against it then the consequences do not bear thinking about.
What if the situation in Greece deteriorate further and at the end of the 3 years she does not repay? This does not appear to have been considered.
Those countries which may loan to Greece include ones which have their own problems. Should the plan be fully activated then Ireland would loan just under 1/2 billion Euros, Spain 3.7 billion Euros and Portugal nearly 0.8 billion Euros. So the other countries will fiscal/debt problems are made weaker and the question how would they be helped if conditions deteriorated ? will I feel be asked more and more often if the world recovery should stall at any point. The biggest issue would be Spain simply because she is a larger economy.
The Cost of Delay
Whilst Europe has been dithering since its first announcement on this subject on February 11th Greece has been issuing bonds. So there has been a price for this delay which can be calculated, Greece has mostly issued at approximately 6.5% which is 1.5% over the rate Europe is now offering so 1.5% each year. On the recent seven-year bond this would mean 75 million Euros a year for 7 years so it is not cheap.
If Greece requested the money now my understanding is that Europe may not be able to provide it. For example Ireland is a relatively small player but she has said she would require new legislation to take part in this plan. I would imagine that she is not the only one. What if individual Parliaments debated and delayed or even said no?
This plan if activated by Greece would definitely help with her liquidity problems in the short-term and get her through 2010. Frankly it would have been sensible for it to have started now (unless some in Europe still hope that talk is enough…….). However in terms of longer-term solvency it is simply not enough.
For example a longer-term interest rate of 5% is still too high for Greece who is in the middle of a very severe austerity programme. There are still many problems likely to come from this which could come in terms of civil unrest or the programme simply not being achieved. I still feel that in the end Greece is likely to have to restructure her debt and reduce par repayments by say 15%.
The Euro zone has been fundamentally weakened over the course of this process. Her leaders have made all sorts of announcements which have been exposed as at best optimistic and at worst outright deceit and there has been far too much dithering and grandstanding. There is still no general crisis resolution system for the Euro zone.
So in the short-term things will improve as the size of this package if it is activated is significant as it is 10% of Greece’s national debt and that is before any contribution from the IMF. I am not surprised that three-year Greek government bond yields have dropped by nearly a point to 6.2% and the yield spread with Germany’s ten-year government bonds has fallen to +3.3% from 4%.The stock market has risen nearly 5% and the Euro as a currency has strengthened. However once knee-jerk responses are over and people have had time to think they will realise that 2010 now has a potential solution but questions remain for 2011 and 2012.
We have seen before that plans which are not fully thought through get challenged by the markets but is usually takes a period of reflection first.