Greece gets its 2nd Bailout

Greece has been on the brink of its second bailout for weeks. The  130 billion bailout was first delayed because of the terms of the deal, where private bondholders would take a “voluntary haircut” to avoid triggering the Credit Default Swap (CDS) payouts. Then it was the details of the austerity package, where Greek Finance Minister Evangelos Venizelos was battling the “Troika” of rescuers (European Central Bank, the IMF, and the European Commission) over the details of  3.3 billion of spending cuts. Finally, the Troika wanted the leaders of all political parties to give written assurances that they will not renege on the deal after elections (penciled for April 8^th). 

According to an IMF report published in October last year, a 50% write-down on private sector bonds, stringent targets set by the EU summit, along with  130 in additional low interest financing would give Greece a decent chance to trim its public debt to 120% of the GDP by 2020, from 160% at present. However, since then, Greece's economy has been in much worse shape; it’s already in its fifth year of recession. Naturally, its rescuers – especially Germany – did not want to plug in the bigger financial hole because Greek politicians had already broken several promises on introducing economic reforms in the past. The implications were dire. If there had been no deal by March 20, when a big repayment of  14.4 billion was due (expiration of sovereign bonds), Greece would have no choice but to default. This would trigger a series of CDS payments (the quantum of which are unknown), and that could cause chaos across the entire financial system. Greece could well even be ejected from the Euro (inevitable in my opinion) since the European governments have failed to build a “firewall” around other high debt-ridden nations such as Portugal, Italy and Spain.

Background

For 30 years, the Greeks lived lavishly. Public spending bloated as cheap funding from the US and the EU seeped in, and as citizens incessantly cheated the system, and routinely avoided taxes. The last 3 years have seen Greeks humiliated and forced to endure hardship. Since the first bailout ( 110 billion) in May 2010, the government has imposed austerity and increased the taxes (not a very bright idea for a culture notoriously renowned for evading taxes). Taxes on restaurants more than doubled from 11% to 23%. Property prices and rents have plummeted but property taxes have tripled. An increase in taxes on cars prompted many drivers to hand in their license plates.

Protests against Austerity in Athens

The middle class has been driven into poverty. Many of the small-to-medium sized family businesses (50 employees or less), which make up of about 99% of Greece’s enterprises and 75% of its private sector workforce have either closed down or have sacked many employees. Big businesses aren’t faring much better either. Close to 470,000 private sector jobs have been lost since 2008. In contrast, the (bloated) public sector has seen not even a single job-loss. The civil sector has had a small pay-cut and a minor reduction in benefits, but no job losses. 
 

As a result, the GDP has contracted 12.5% since 2008, and is expected to fall by another 4% this year. Unemployment rate is at 19%, but youth unemployment is close to 50%. Those who do have jobs are over-qualified, underpaid, and overtaxed. In their frustration, they have taken to the streets in protest. Not surprisingly, both, crime rate and homelessness have been surging while investments have practically halted. 

Brinkmanship

Official Handover from Papandreou to Papadamos in November

The leadership battle started in Greece after George Papandreou stepped down halfway through his 4-year term, handing the power to Lucas Papademos. Mr. Papademos, a former ECB vice-president, has already suggested that he will not run; he is expected to take an academic post in America. So the current finance minister Evangelos Venizelos is the socialist party’s front-runner to succeed Papandreou. But preoccupied by the bailout and debt restructuring process, he has hardly been able to campaign. Little wonder that many observers believe that he may have to spend some time in Opposition first.

Evangelos Venizelos (Panhellenic Socialist Movement)

Antonis Samaras (New Democracy)

On the other hand, there is the leader of the conservative New Democracy (ND) party, Antonis Samaras. In opinion polls, his party has an unassailable lead with 33% of the vote, however that is not enough for a clear majority. Hence, the most likely outcome is for Greece to have a coalition party rule. However, a major concern remains the discontent among citizens, many of whom may not even bother to vote at all. They blame not only the New Democracy who was a reckless borrower when in power, but also the Panhellenic Socialist Movement (PASOK) failed to clean up the mess. Also another crucial concern is that without the calm leadership of Papademos, the coalition of populists may not fare well for reforms. Further street unrest could test politicians' commitment to cuts in wages, pensions and jobs. Hence, one cannot blame the Triorka for its lack of trust in Greek politicians, and the reluctance to bail them out.

The Bailout Arrangement

At 5 AM local time (0400 GMT), after 13 long hours of discussion, the Eurogroup of Finance Ministers, chaired by Luxembourg’s Prime Minister Jean-Claude Juncker, finally agreed on the second bailout package for Greece. In return, Athens had to commit unpopular and painful cuts, and private bondholders had to take even bigger losses. The deal still leaves doubts about Greece’s ability to recover, and avoid the default in the long term; but it does buy the 17-nation currency bloc to buy some time to strengthen their ‘firewalls’. The response to this was very dull as expectations of an agreement had been largely priced into financial markets.

As mentioned already, one of the biggest concerns of the deal is the pain that private bondholders have to bear. They will be offered new government bonds with only 31.5% of the principal value, at lower yields and maturities ranging between 11 and 30 years. They will receive another 15% in short-term bonds back by the Eurozone’s temporary bailout fund. The resulting loss of 53.5% is higher than the 50% that was agreed upon in October, but it was necessary to give Greece a fighting chance. This could cause problems in the future as private investors may stay away from Eurozone nations (such as Portugal or Spain) that may need a bailout later.

The Euro zone central banks will also play their part. According to a Eurogroup statement, the ECB would pass up profits it made from buying discounted Greek bonds (over the past two years) to the national central banks so that their respective governments can further pass it on to Athens. This would “further improve the sustainability of Greece's public debt.” The ECB has bought Greek bonds with Face Value of  50 billion on a 24% discount (i.e. for only  38 billion).

Usage of the Bailout Funds

The bond-swapping process for private bondholders, expected to take 3 days, will start on 8^th March. This means that the  14.4 billion bond-repayment, due on March 20^th, will be restructured and Greece will avoid a chaotic default. While a vast majority of the bailout money will be used to finance the bond-swap, some  30 billion will be needed for “sweeteners” to convince private bondholders to sign-up. The remaining funds will be used to cover the budget deficit, recapitalize Greek banks, and finance a bond-buyback. At the end, almost nothing will be left to actually stimulate the Greek economy.

Growth in Austerity

The highlight of the bailout is the demand for austerity from Greece. While it may sound only fair that the Greek Government tightens up its purse strings, it may not exactly be the best approach as it could well lead to a downward debt spiral. Some of the features of the austerity package include a 22% reduction in minimum wage, another round of pension cuts, and 15,000 public-sector job cuts. Mr. Venilezos called these demands “unrealistic” and “farcical” before giving in. Spending cuts are also demanded are in the sectors of defense and healthcare, and to scrap the habit of paying “holiday bonus”. All in all, Greece has been asked to make further cuts in Government spending of 1.5% of GDP. Furthermore, from 2013 Greece is supposed to sustain “primary” budget surpluses (i.e. excluding interest payments). To do this, the government has been considering privatization of national assets such as land, utitilities, ports, mines, etc. 

German finance minister Wolfgang Schäuble suggested that the Greek elections be postponed and a small technocratic government be set up like Italy’s for the next two years to carry out reforms. But the Greeks have now grown resentful of what they regard as German high-headedness.

In such an environment of social upheaval, political uncertainty, insufficient capital, it is not hard to see why Greece has been Eurozone’s most troublesome child; couple that with Eurozone’s out of sync monetary policy, and lack of fiscal unity, and what you get is a system designed to collapse under its own weight. Many economists doubt that Greece will ever be able to pay off even a reduced debt burden, and hint that the bailout has only pushed the can down the road, and Greece will eventually default. After all a return to economic growth could take well over a decade. Little wonder that rating agencies have downgraded Greece and several other Eurozone economies. Yields on Greek bonds have been above 30%, compared to less than 3% on German bonds. However, Considering that Germany has the highest exposure to Greek debt after France, they find themselves stuck in a Catch-22 situation.