At the end of July an event took place which European investors were looking forward to – EU leaders presented another plan which would enable Greece to overcome its debt crisis and gave the green light to a new injection of financial aid. Following a short period of enthusiasm, experts became divided into two camps, with the pessimists insisting that default is inevitable in Greece, while the optimists are convinced that the situation will gradually get back to normal.
Igor Zuyev, Rietumu Bank analyst
Support Plan for Those Who Lag Behind According to the decisions taken by EU leaders, Greece will receive another package of financial aid, and public bonds with expiring maturities will be exchanged for longer dated bonds. It turns out that the scenario we forecasted two months ago has proven to be true.
The plan of assistance for Greece is laid out as follows: the European Foundation for Financial Stability (EFSF) and the IMF will provide financial aid to the country to the song of about EUR 109 billion within the next three years at the reduced rate of 3.5%.
Private creditors can ‘voluntarily’ exchange Greek public bonds that are due to mature in the coming years any time, prior to their expiry term or upon it, with much longer dated bonds of up to thirty years which is, in point of fact, an extension of the maturity terms for the public bonds.
The Institute of International Finance (IIF), which unites the 400 largest banks from more than seventy countries, has declared that its members are ready to participate in an exchange of public bonds. According to the preliminary estimates, the degree of participation for the banks in the exchange will amount to 90%. If this figure is not achieved, Greece will not be able to fulfil its debt obligations and it will mean an inevitable default. Let us note that there are positive examples to be drawn from similar situations in the past: for instance, when exchanging Uruguayan bonds, the participation level was 93%.
The EFSF, which has a volume of EUR 440 billion, will also gain more leverage which will allow the debt crisis to be prevented from spreading to other eurozone countries. In particular, the conditions for granting loans will be simplified. For Ireland and Portugal, the EFSF credit interest rate will be reduced from 4.5-5.8% to 3.5%, and the terms will be extended from the current 7.5 years to 15-30 with the ten year grace period. Due to the reduction in the interest rates, there will be less need for a second package of aid for these countries.
The Foundation can also buy out public bonds from eurozone countries on the secondary markets in order to regulate prices, grant loans to the countries prior to them losing access to the private investment market, and finance the recapitalisation of banks. Thanks to this, we can speak about the creation of a European monetary fund, which is similar to the IMF.
Inevitable Losses The exchange of Greek public bonds will entail losses: as a result, the largest banks in Europe may lose EUR 20.6 billion (the ninety largest European banks hold about EUR 98 billion in Greek public bonds). However, it will not become a catastrophe: the banks are able to cope with such losses.
Besides, according to estimations by Britain’s Barclays Bank, a little more than half of EUR 350 billion of Greek debt is in the portfolios of private investors, primarily based on the balances of European financial institutions.
Those losses to be suffered by the private sector will depend on the discount rate, which determines the expected reduction of the bond payments over a certain period of time. JPMorgan Analysts have calculated that the discount rate will be approximately 12% by considering the weighted average yield of Greek public bonds. The anticipated IIF rate is 9%. With such a discount rate, losses for investors will not exceed 21%.
In this situation these are, so to say, inevitable losses. The chief achievements of the summit of EU leaders has been in providing capital to those Greek banks which bear high exposure levels to the Greek debt crisis and in preventing the crisis from spreading to other eurozone countries. These measures, as a whole, will allow a collapse to be prevented not only in Greece, but also in other eurozone countries, which are much larger than Greece.
Nevertheless, international rating agencies are obviously not fond of the decisions that have been taken at the summit of EU leaders. Moody’s and S&P have already managed to lower the rating for Greece to a level which is just one step above a default. When the public bonds exchange plan begins to be implemented, Greece will be awarded the SD (selective default) rating.
Now it is up to the Greeks It was already clear some time ago that the financial assistance provided to Greece last May would not be sufficient. It is obvious that European leaders were aware of the necessity to take new measures. However, dissatisfaction by taxpayers and the ‘moral hazard’ factor did not allow the leaders of Germany and France to provide Greek authorities with another quick package of aid.
Calling the current situation a default would be an extreme exaggeration - instead it would be much better to characterise it as a restructuring, one which in this situation seems to be an option that is quite acceptable for all parties. With such a huge level of Greek debt, the creditors could not hope to avoid losses completely. Therefore, a scenario in which investor losses reached about 21% seems to be the best choice available.
Due to the current plan, Greek debt in terms of GDP will stabilise at about 150% for the next decade whereas, without the restructuring process, it would reach 250% by 2030. Payment of the nominal value is extended for a longer period within which the Greek authorities will have time to put their finances in order: to increase the revenue side of the budget and to continue along the course required to reduce budget expenses.
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