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.
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| Protests against Austerity in Athens |
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
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| Official Handover from Papandreou to Papadamos in November |
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| Evangelos Venizelos (Panhellenic Socialist Movement) |
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| 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 8th March. This means that the 14.4 billion bond-repayment, due on March 20th,
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.
