Yesterday saw yet another ratcheting up of the Greece crisis on both the market and the political level. I feel that it is one of the most revealing aspects of this crisis in that what politicians consider to be a valuable weapon, talk and promises, now actually makes the situation worse. There was an interesting piece of research from BNP Paribas last week which looked explicitly at the cycle Greece was in which went as follows. 1. Greece gets hit on markets,2. Politicians talk and bluster,3. A small rally and some time is bought,4. Market sees through bluster and Greece gets hit on markets and so on… However on Friday the rally section (3) lasted for three hours at most and yesterday there was no rally at all from Chancellor Merkel’s statement explaining Germany’s position, instead Greece was hit again. The financial markets are showing little mercy to a country that in boxing terms is plainly on the ropes.
What did Chancellor Merkel say?
“We need a positive development in Greece together with further savings measures,” and “Germany will help if the appropriate conditions are met. Germany feels an enormous obligation towards the stability of the euro.” and “If Greece is ready accept tough measures, not just in one year but over several years, then we have a good chance to secure the stability of the euro for us all.”
What does it mean?
Germany wants a three-year austerity programme from Greece that is both specified and harsh or she will not loan her any money. When you look at how confident (blustering) politicians usually are in their statements I think the use of “good chance ” is significant. Similarly the phrase “We need a positive development in Greece” is revealing (apart from contradicting virtually every statement up to this weekend from all euro zone officials and politicians) as again it suggests that Germany wants to apply a policy of tough love to Greece. It introduces a further element of doubt into Germany’s proposed aid package for Greece.
Chancellor Merkel did not say it but it is plain that she would like to delay signing any cheques to Greece until after the election in North-Rhine Westphalia on the 9th May. According to opinion polls aid for Greece is unpopular in Germany. So I guess she joins UK politicians in trying to put off difficult decisions until after an election, so much for the concept of an informed electorate making their choices in a vote! Let them know as little as possible appears to be the watchword in Germany as well as the UK.
Apparently I gather from German sources that dithering and vacillating has been a feature of her administration and they even have a phrase for it Sich durchmerkeln which apparently means “to Merkel through.” So I guess that inside Germany the shambolic response to Greece’s problems has not been a surprise. I am grateful to CNBC for a full translation. “to bumble along without commitment, hoping that a critical situation will solve itself by postponing decisions.” Sounds familiar doesn’t it?
This policy will cost Europe a lot of money as if the right decisions had been taken say 3 months ago the German taxpayer would be facing a smaller bill and Greece would be in better shape.
This is best represented by referring to my article on the 22nd April.
What does this mean if you bought at one of the recent issues?
On March 11th Greece issued 5 billion euros of a ten-year bond with a coupon of 6.25% at a price of 98.742 according to the Greek Public Debt Management Agency. So by my maths it was yielding 6.33%. At last nights closing yield of 8.1% I estimate that investors have lost over 11 points. For a bond market that is quite a rate of capital loss, 12% in just over a month or 600 million euros. It will hardly encourage them to buy again. As it was heavily over-subscribed it turned out that many were lucky to miss out.
Last night that particular bond closed at 79.16 according to Reuters. So since the 11th March nearly 20 points or pretty much 20% has been lost. For a sovereign bond this is a staggering loss over such a short time period, as it amounts to 1.2 billion Euros.
If one looks at the yield on this bond it is 9.53% and this is now over three times Germany’s equivalent bund. The shorter end of Greece’s government bond yield curve is at even higher rates with her 3 year bond yielding 12.58%
The three-year bond yield is significant in two respects. Firstly I suspect it will be the yield raised in the German Constitutional Court to calculate a “subsidy” for Greece and as it is now 7.58% over the proposed cost of Greece borrowing from the euro zone I am looking forward to the official explanation of how this is not in effect a subsidy. Secondly shorter term yields exceeding longer term ones means the bond markets are afraid of restructuring and default. I cannot blame them for that.
Others are pointing out that Greece’s equity market is not pricing in fear of default in the same way. This is probably true but I have seen this before where bond markets move 4, 5 or even 6 months before equity markets in response to general problems. This morning Greek bank prices are falling because mortgage covered bonds of Greece’s three biggest lenders were cut or placed on negative review by Moody’s Investors Service.
As Greece’s position has deteriorated I have feared for Spain and Portugal as they have been in danger of being sucked into this crisis. The main problem is that once it starts it becomes self-fulfilling. If you feel that a country’s fiscal position is in trouble and you sell her bonds and the price falls then going forward the costs of financing that countries national debt rise and the fiscal position deteriorates maybe leading to someone else selling her debt and so on….
I have mentioned Portugal’s situation before particularly in my articles on the 16th and 22nd of April. She appears now to be actually being sucked into Greece’s tailwash. Just as a reminder she has a fiscal deficit of 9.4% and a national debt of around 77% of Gross Domestic Product(GDP) which will rise to 85% at the end of this year. Like Greece she is not accounting for the interest outright on her national debt, instead she is rolling it up and adding it to her debt. However in many respects her situation is different and I wish to explain those differences today.
Lack of Growth
Since joining the Euro Portugal has had the slowest growth rate of the euro zone nations which contrasts her strongly with Greece who was growing (assuming you believe the numbers) at around 3/4% per annum over this period. Portugal has had an average rate of less than 1% over this period. This has been caused by several factors.
1. There has been a “brain drain” where many educated Portuguese emigrate although because of EU rules it is hard to get exact numbers.
2. Portugal had and has quite a few industries which are price competitive and these have been affected by the growth of price competitive manufacturing in China and the Far East as well as in Eastern Europe.
3. Portugal had a privatisation programme for many utilities but it would appear that there has been a form of “soft corruption” where ex-politicians rather than businessman have been appointed to the boards of such firms making them inflexible and the reverse of dynamic.
4.Portugal has rigid labour laws, which there is little political will to reform and she has one of Europe’s toughest employee-protection regimes.
So sustained low growth has put pressure on Portugal’s public finances but to be fair she has tried to address them. In the period 2005/07 she set her stall out and took some tough fiscal measures and cut her budget deficit in half, from 6.1% of GDP to 2.6%. For example there has been reform of Portugal’s pension system which means that she is a European leader in this area. But the credit crunch knocked her off course and her low growth rate this century has returned to haunt her.
Portugal has been badly affected by a loss of economic competitiveness as her low value products have simply been under cut by others.She is trying hard to change but this will take a timescale which financial markets will not give her.
A Possibly Fatal Error By Her Government
This fiscal year the Portuguese government issued a new Stability and Growth Plan (SGP).However unlike the plan for 2005/07 it was more a letter of intent than a specified plan. Also it became plain that the intent was to try to delay any real change and postpone difficult decisions to the future and in particular to future governments and taxpayers. This was immediately seen through by financial markets I feel and made Portugal vulnerable to a change in sentiment in financial markets. Perhaps the most complacent section of the SGP was the announcing of a target reduction in the public deficit of a mere 1% of GDP for 2010 (from 9.4% to 8.3% of GDP).
Portugal is in her current position for two main reasons and one she shares with Greece but the other she does not. Her main problem has been a lack of growth and this has caught her out in her plans for her public finances and left her vulnerable. The bit she shares with Greece is that her government lost its nerve at a crucial time and dithered. If it had responded positively like Ireland’s government then she would not be facing the issues and problems she has now.
As an example of this her ten-year government bond yields were 4.18% at the beginning of April and they closed last night at 5.23%. The spread over Germany’s ten-year bund has risen to +2.17% whereas it has spent some time around +1.2%.
I believe that there is still a window for Portugal but that she would have to grab it now. Further reductions in her deficit with cuts and tax rises which impact in the next year still have a chance but that chance may now be fleeting. Please take it Jose Socrates the alternative is worse and Sich durchmerkeln will simply not do.
Just a Thought (4.15pm)
Portuguese three-year government bond yields have now risen above 5% partly because she has just been downgraded. The significance of this will not be lost on people who understand that she will be expected to provide funds to Greece at 5%……..