Saturday 12 March 2011

The good news from Brussels – and the problems which remain

Against all indications to the contrary, the Eurozone appears to have agreed to a sensible rescheduling of Greek debt, according to the Greek news media, at least. According to these sources, the following commitments have been made in Friday’s meeting in Brussels:

a.       The loan term is extended from 4.5 years to 7.5 years
b.      The interest rate falls from 5.2% to 4.2%
c.       Greece commits to EUR 50 billion in privatisations over the next 3-5 years.

The first two revisions alone are a cause for celebration, since some element of rationality appears to have re-asserted itself. It remains to be seen what the final agreement will be, however, and given the many changes in EU decision-making, it is important to see the text of a final document ratified by the Member States. Should these changes materialise, this author will be the first to congratulate George Papandreou and the Eurozone leaders for taking this modest step.

Unfortunately, the core problems facing Greece and its debt are largely unchanged, and we believe the chances of a successful implementation will be next to impossible, for the reasons already related as regards the privatisation programme as well as the fact that the Greek governmnt owes a further EUR 230 bln to private creditors, which has not been restructured. In other words, the core scenario expressed by Moody’s and this blog still applies.

Let us compare the magnitude of the EUR 110 bln debt repayment, and see what conclusions can be drawn for the repayment of private sector debt (which continues to be difficult to model due to fragmented data available from the Public Debt Management Agency).

Under the current EUR 110 bail-out scenario, the Eurozone interest rate is 5.2% (the IMF portion is slightly lower, but for the purposes of modelling we will use a common rate for IMF and Eurozone debt tranches), while the loan terms include a 3-year disbursement period and a 4.5 year repayment period.

In Figure 1, repayments of EUR 32.10 bln would start in 2014, with the final payment occurring in H1 2018. On the principal of EUR 110 bln, a total of EUR 34.46 bln in interest would be charged. Greece would therefore pay back a total of EUR 144.46 bln.

Figure 1: Original EUR 110 bln Loan Package (click to enlarge)

Under Option 2, which was agreed Friday night / Saturday morning, the interest rate falls to 4.2% while the loan repayments are spread over 7.5 years. As seen in Figure 2, annual repayments of EUR 19.14 bln start in 2014, expiring in 2021. The total interest paid by Greece over this time is EUR 33.58 bln, reflecting a lower interest rate of 4.2%. We do not know if the Eurozone and IMF interest rates will be harmonised to this level or not, but we assume for the purposes of modelling that they are.

Figure 2: Proposed Revision, EUR 110 bln Loan Package (click to enlarge)

So far, so good: the revised terms of the EUR 110 bln “bail-out” are excellent for Greece. But the key problems remain:

·         How will Greece refinance and pay off its private sector debt, which is over twice the level of the Eurozone/IMF debt? If we assume that 8-10% of 2014 GDP will be needed to pay off the Eurozone/IMF debt alone, where will the remaining resources come from?

·         Will it be able to meet the strict terms of the Eurozone/IMF bail-out, which has absolute seniority over payment terms? Can it generate a GDP surplus of 8-10% needed to pay off the EUR 110 bln starting in 2014? 

·         Will it have the political will to implement the EUR 50 bln privatisation programme and the other conditionalities required? In particular, given the dramatic worsening of unemployment (now over 14%), company closures and declining GDP, how will it meet its revenue forecasts? Will it be able to sell EUR 50 bln in the time frame envisaged?

While we remain in hopes of another miraculous solution, our core scenario remains in place:

a.   It will be politically impossible for Greece to gain privatisation revenue of EUR 50 bln, unless drastic securitisation of future revenue is used, which will cause further financial problems in the future.

b.   Greece will not be able to achieve a surplus necessary to repay the Eurozone/IMF debt, let alone the private sector debt. This has never before happened in Greece’s history, and so far the record of the PASOK government’s implementation of existing conditionalities has been hesitant and partially ineffective.

c.   The only solution remains a restructuring of public debt owed to private sector debt, involving a haircut of at least 30% of principal, an interest rate freeze and an extension of principal repayments.

This may well be among the first operations of the EFSF successor from 2013-2014 onwards. Any alternatives to this, including Eurobond issue or EFSF open-market bond restructuring, merely postpones the inevitable and transfers the risk from private to public creditors.

© Philip Ammerman
Navigator Consulting Group

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