Investors are reacting with a mixture of weary skepticism and indignation to the new rescue package for Greece, which accepts that a huge portion of Greek debt will never be repaid.
Yields on Greek government bonds have risen in the days since the deal was announced on Tuesday, early in the European morning, as investors digest the scale of the economic challenge that Greece faces despite the emergency injection of €130 billion by the European Union and International Monetary Fund. Euro zone equity prices have fallen for three straight days.
Société Générale said, in an economics note, that Greece was “increasingly trapped in a vicious circle,” where austerity in government spending, forced by the need to narrow its fiscal deficit, would hit growth ever more severely.
Richard Woolnough, fixed-income fund manager at M&G Investments in London, criticized the harsh terms imposed on private sector bondholders, which will be forced to write down considerably more than half the value of their debt under the new agreement. Woolnough said, “This PSI [private sector involvement] precedent means that in the future, should a government debt crisis occur, private investors will be less willing to support troubled government debt, and speculators” — who have made money from betting on the decline in Greek debt values — “will be rewarded for being short. Obviously this will impact the sustainability of government finances at precisely the time they would be seeking to generate confidence in their ability to service their debt obligations.”
The yields of Portuguese sovereigns have increased as well on fears that the write-off of much of the value of private investors’ Greek bonds might establish a precedent for the debt-laden Iberian country.
Analysts agree that Greece has a mountain to climb following the new deal.
Euro zone finance ministers have agreed on a package designed to reduce Greek debt from the current level of 160 percent to 120.5 percent of gross domestic product by 2020 — still an extremely high burden by the standards of most countries. Greece’s rapidly shrinking economy means that to achieve even this, euro zone ministers have been forced to make many concessions. These include asking private bondholders to write down the face value of their bonds by 53.5 percent.
Moreover, Deutsche Bank estimates that the total effective write-down for private sector bondholders will be about 75 percent. This is because investors will swap their debt for new loans that carry lower coupons than the present ones and because the new loans will allow Greece to pay back the debt more slowly.
Analysts are skeptical that Greece can meet even this massively reduced debt burden. The new agreement assumes that the Greek economy will stop shrinking next year after five years of recession — creating a stable tax base from which the debt can be paid. But Capital Economics, an independent macro economic research consultancy, forecasts a 7 percent contraction in the Greek economy in 2013 following an 8 percent drop this year. Ben May, European specialist at Capital Economics in London, said, “If this is the case, the troika is almost certain to force Greece to implement further austerity measures to meet the existing budget deficit plans. At that point, Greece might walk away from the deal and default.”
It is also possible, in any case, that the Greek bailout could be scuppered at a considerably earlier stage. In addition to Greek parliamentary cooperation, the deal is dependent on the approval of several national parliaments, including two countries where there is considerable public opposition to helping Greece financially: Finland and the Netherlands.
Most private holders of Greek bonds are likely to accept the terms of the agreement. If they do not, Greece is set to default on all its debt — leaving them with no returned money at all. But several institutional investors bristle at the fact that the agreement asks them to accept such a large level of debt forgiveness, while euro zone central banks that hold Greek debt will not have their debt written down.
Some analysts see the Greek deal as another example of a phenomenon which institutional investors will increasingly have to take into account in the coming years, as governments face hard choices over tax and debt: the phenomenon of “financial repression.” Financial repression occurs when governments use their political and legal power to impose costs on investors and citizens to avoid having to bear the costs themselves. Examples include forcing them to pay for debt defaults, higher taxation, or reducing the value of their savings by allowing higher inflation in order to reduce public debt burdens. Defenders of the Greek debt deal, however, argue that euro zone governments are bearing their share of the burden by contributing to the bailout package.
Despite the flaws in the new package for both Greece and private investors in Greek debt, some analysts see the fact that a deal has been achieved at all as a reassuring sign that the euro zone system has the capability to step in to prevent total meltdowns in sovereign debt — whether in Greece or in other troubled euro zone economies in the future, such as Portugal and Italy.
Deutsche Bank said, in a research note, that the agreement “demonstrates the willingness among European member states to limit systemic risks.”
By the end of Thursday European trading the yield on the Greek benchmark 10-year bond had climbed by 232 basis points (bp) since the deal was announced to reach 36.90 percent, with yields on Portuguese 10-year debt 36bp higher at 12.58 percent. The Eurofirst 300 index of euro zone equities was 1.4 percent lower at 1,075.
