Greek government debt was further downgraded last week by Moody’s, with the agency noting that there is “an even chance of default over the rating horizon”. This latest action surprised few in the markets, with most investors wellversed in the fiscal story and the subsequent arguments around a possible debt restructuring. This latest action by Moody’s is, however, indicative of a wider (and growing) concern as to how the euro area will exit the current crisis. …
David Scammell, Head of European & UK Interest Rate Strategies
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Greece was given an EU/IMF €110billion loan package in May last year, conditional on stringent fiscal consolidation. Since then, the Greek government has made the largest fiscal adjustments of any European country, resulting in the primary deficit falling by an impressive 5.5% of GDP last year. Unfortunately, these austerity measures damaged the growth outlook and there is now clear evidence of fiscal slippage. Thus, net revenues to the Greek government fell by 9.2% in the first four months of this year compared to the same period in 2010, against a target increase of 8.5% for the year as a whole. This is not good news – the obvious conclusion is that Greece is beginning to fall behind target, and will require further financial assistance in upcoming years – in particular, there is a funding shortfall of €60-70 billion over the period 2012-13. Given the magnitude of the numbers, it is easy to argue that debt sustainability is simply unattainable and the country is insolvent.
We would argue that the costs of a near-term debt restructuring far outweigh the benefits – both for Greece itself and for the entire euro area.”
As an alternative to more EU/IMF support, many investors now hold the view that a restructuring of Greek debt is not only inevitable but also desirable in the near-term. The main argument in favour of such a move is that postponing the inevitable merely makes the restructuring more painful in the future. Moreover, it is already priced into the markets.
Of wider consequence, restructuring could prove highly destabilising to bond markets, with significant contagion effects on the other periphery countries. Attention would turn from Greece to the other peripheries, with investors revising up the probabilities that they assign to restructuring elsewhere. This would obviously be very bad news for the euro area.
We suspect that most politicians appreciate this danger and that is why we do not envisage any debt restructuring or maturity extension this year. Rather we suspect that the way forward will ultimately be the full socialisation of peripheral debt – in other words, a long drawn-out process of fiscal transfers from sovereigns that are still solvent (Germany).
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Source: IFAWorld – Schroders