Greek Drama

28/04/2011 at 3:36 pm

There has been a lot of talk lately about restructuring Greek sovereign debt. Greece failed to meet its deficit reduction target for 2010; its debt on a Maastricht basis stands at 143% of GDP; its austerity programme saw the national economy shrink by more than 6% over the course of 2010; unemployment has risen to 15%. The country’s credit ratings are low and still sinking. Most alarmingly, Greek bonds have sold off to the point where two year yields have reached 24% – 10% higher than where they were a month ago. Some kind of sovereign default must be round the corner.

And yet … Greece’s underlying problems would not be solved by debt restructuring – problems it has already begun to address. Yes, a budget deficit of 10.5% is abysmal, but that’s down by almost 5% on the year: a fiscal consolidation not even close to being matched by any other country in Europe. The Greek government has also embraced a programme of privatisation and land sales to bring down its debt burden. All this is being accomplished in the teeth of fierce opposition from trades unions and large swathes of the public.

Beyond Greece too, what would a restructuring accomplish? Nobody knows for certain what the effect would be on the balance sheet of the financial system, including the ECB, and on Greece’s existing sovereign creditors, but it would be far from benign. And once the precedent of a restructuring was set, surely Ireland would be next in line to be pushed over the cliff (2010 deficit: 32.4% of GDP). Perhaps Portugal might follow.

At that point, the harbingers of Euro-doom could be proved right: we might witness the collapse of the single currency zone. The global fallout from that would likely make Lehman Bros look like a picnic. Which is why – to take one example – China has been piling into European investments, including government bonds. The world does not want another crisis, and a sovereign collapse in the eurozone could be just the catalyst to make it happen.

These remain uncertain times. The recent election in Finland serves as a reminder of the unpopularity of bailing out bankrupt states. And Greece has serious problems.

We should be careful, however, not to write off the possibility that Greece, and the other countries in crisis, find time and support enough to muddle through without resorting to default. It is also possible to envisage a “minor” restructuring of Greece’s debt – such as an extension of maturities and / or capitalisation of interest for a few years, arranged so as to have a neutral effect on the value of the instruments concerned – that could be helpful to the Greeks without sparking serious contagion (though the risks would be high).

In other words, the bears may have their day again soon: but on the other hand, Greek debt could present the bond market opportunity of the decade.

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