New Debt Plan for Greece but Same Old High Yields

Yields on Greek benchmark 10-year bonds, at 18.24 percent as its first week of trading closed, are the highest in the euro zone. This suggests further trouble ahead in spite of the country’s much-reduced debt burden.


Yields on the Greek government’s brand new bonds are already trading at distressed debt levels — suggesting that despite February’s bailout package investors still see a strong chance that Greece will not be able to sustain even its much-reduced debt burden.

As the first week of trading closed, yields on the benchmark 10-years were at 18.24 percent — down from Tuesday’s closing high, but still the highest in the euro zone.

The new bonds have replaced old Greek paper, under a massive €206 billion ($273.5 billion) exchange program that swapped old bonds for new ones carrying lower coupons.

The high yields — the most elevated by far in the euro zone — reflect skepticism about whether the latest rescue deal, based on an orderly default of Greek debt, is enough to prevent a second default in the future. Last month private sector creditors reluctantly agreed to an effective default of 75 percent of the value of their debt, in a deal masterminded by euro zone finance ministers.

Assessing Greece’s ability to meet its fiscal challenge, Mike Turner, head of global strategy and asset allocation at Aberdeen Asset Management in Edinburgh, said, “The aim of reducing the country’s debt-to-GDP ratio from 160 percent to 120 percent by 2020” — the timetable envisioned by euro zone ministers when they put together the second bailout package — “still looks an impossible task without further write-offs.”


The heart of Greece’s problem is that it needs first to halt a rapid decline in its gross domestic product — which could amount to 8 percent this year. Having achieved this Herculean task, it must then start growing its economy again.

An expanding economy would boost tax receipts, allowing it to pay down debt.

But achieving this is an extremely tall order for several reasons, say analysts.

The cuts in spending made to close Greece’s fiscal deficit have already meant redundancies for thousands of government workers, which has cut household consumption. As a result, Greece is in its fifth year of economic contraction — one of the longest recessions suffered by a country in modern global history. This has hit tax revenues — forcing even more cuts in spending that create a vicious cycle.

A second problem is that even in normal times, Greece lacks the ability to generate fast economic growth for a sustained period.

Hans-Peter Keitel, president of the Federation of German Industries, called in February for a new Marshall Plan sponsored by German investors to reinvigorate the Greek economy — modeled on the U.S. program after the second world war that boosted Europe’s economy by pumping money into rebuilding industry.

He made clear, however, that before foreign investors would be willing to enter Greece, its government must create certain structures essential to an efficient modern economy, such as a well-functioning land registry and effective tax collection — features that took root in many other European economies decades, if not centuries, ago.

In addition to the problems identified by Keitel, foreign investors’ faith in the predictability of the Greek legal system is so shaky that even hedge funds specializing in distressed debt are often wary of entering the country to pick up bargain assets.

Economies that are as inefficient as Greece’s often compete, instead, by offering goods and services at much lower cost than their rivals.

But this is a tricky feat for Greece to pull off. It cannot gain the necessary price advantage through letting its currency devalue — because, as a member of the euro zone, it does not have its own currency.

An alternative — pushing down wages aggressively in an effort to compete through lower labor costs than rivals — could temporarily cut GDP even further by sending Greece into a spiral of falling domestic demand and increasing unemployment. This fear was raised by this year’s joint report on Greece’s debt sustainability by the European Central Bank, European Commission and International Monetary Fund.

In other words, if Greece does not reform itself, its debt may spiral out of control; and if it does reform itself, its debt may still spiral out of control.

Many of these problems are common to other peripheral euro zone economies stuck in the economic doldrums, including Italy and Portugal. They are both suffering from the powerful recessionary effect of spending cuts and tax increases, uncompetitive economies, and an inability to address a lack of competitive advantage through currency devaluation.

Investors are particularly fearful that Portugal could find its debt burden unsustainable. It is just above 100 percent of GDP and rising, despite a series of structural and fiscal changes implemented by Vitor Gaspar, finance minister and former senior official at the ECB, that could have come out of a ‘how to’ manual for economic reform written by the Frankfurt central bank. Thursday’s closing rate for the Portuguese 10-year were, at 13.85 percent, 163 basis points higher than in mid-February, before the bailout terms were announced.

Jonathan Loynes, London-based European economist at Capital Economics, the independent macro economic research consultancy, said that while he remained worried about Greece’s fiscal sustainability, “the focus will surely return to Portugal later in the year as its first bailout nears an end.”