Greece is now likely to avoid a messy default next month, but in the longer term the plans behind the latest bailout are optimistic…
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Subject to an extensive set of conditions, Greece will now have access to an additional €130bn until 2014, meaning it is likely to avoid a messy default given it is due to repay €14.5bn as a bond matures (plus €1.5bn in interest) on 20 March.
In exchange, Greece has agreed to implement austerity measures with the aim of reaching a primary surplus (excluding the cost of debt financing costs) by the end of 2013.
According to the Greek Statistics Office, the primary deficit stood at €5.3bn, or 2.4% of GDP. While that sounds achievable over a two-year period, the problem is the ongoing recession in Greece. The economy contracted by 5.3% in nominal terms last year (7% in real terms), which means if the same decline were to happen again this year, then achieving that target by the end of 2014 will be even more painful. However, if all goes to plan, Greece will have reduced its level of debt to 120.5% of GDP by 2020.
The bailout also requires the private sector to take a 53.5% nominal haircut in the value of the Greek government bonds they still own. This is slightly larger than the initially muted 50% haircut, but is lower than recent rumours had suggested it could be. We have been sceptical on this in the past as by our estimation, about 40% of Greek debt is now held by the official sector. Therefore, we are pleased to see that in addition to the private sector involvement (PSI), official institutions (European Central Banks and individual governments) will now also be involved. Official creditors have agreed to recycle some of the income/profits generated from bailing out Greece back towards helping the country further in the future. They have also agreed to retrospectively cap the borrowing cost for Greece to a margin of 150 basis points, which will reduce Greece’s debt by 2.8% of GDP by 2020, and reduce its refinancing cost by €1.4bn.
Finally, more money will be made available for the recapitalisation of Greek banks, who will take a significant hit from the PSI deal.
Overall, the plan is ambitious, which is a polite way of saying optimistic. The immediate hurdles to the plan will be the finalisation of the PSI deal, and the implementation of a number of legal reforms required to help enable the external monitoring of Greece’s progress. In addition, the agreement has to be ratified by individual member states, which always creates an opening for opportunistic politics. However, if this is all completed, the International Monetary Fund and European Union should finalise the deal by the Eurogroup and ECOFIN meetings on 12 and 13 March.
Longer-term, the plans are optimistic, bordering on the fanciful. In our view, the level of austerity required by the plan would plunge Greece into an economic depression. Another risk will be the upcoming elections currently scheduled for April. The incumbent centre-left PASOK party and the centre-right New Democracy party now receive less than 50% of the popular votes in Greek media polls. The move away from the centre and towards extreme left and right wing parties is a concern. Given the awful implementation record of the current government, who enjoys a solid majority, what hope does Greece have if a grand coalition takes over?
Moreover, the plan requires a fairly benign external environment to support demand for exports once Greece regains some form of competitiveness. The likelihood that Europe does not experience a recession in the next eight to nine years is somewhere between low and nil.
We think that a return of sovereign crisis risk over the next year remains very high, and we cannot rule out the prospects of Greece eventually leaving the monetary union.
The views and opinions contained herein are those of the Kevin Murphy and Nick Kirrage, Specialist Value UK Equity Fund managers and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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