By Dimitris Kontogiannis
Many analysts and others have expressed caution about the heightened political risk ahead of this year’s twin elections for local authorities and the European Parliament. However, market participants seem to disagree, with Greek equities making their strongest start in many years and bonds rallying aided by upbeat sentiment on the euro periphery after Ireland’s successful sale of government debt. It is clear foreign investors are willing to downplay Greek political risk in their calculations, at least for now. Although financial markets sometimes make mistakes, we should not rule out the possibility they are right about Greece this time around.
The general stock index of the Athens bourse added gains of 7.5 percent last week, bringing the total for the year to about 11 percent. The gains have been underpinned by the strong performance of bank stocks, despite talk of additional capital needs, following the BlackRock stress tests which could have led to share capital increases. Banks are typically cyclical plays in the stock market jargon since their earnings have a high correlation with the country’s business cycle. So, their double-digit gains since the beginning of 2014 point to market expectations for an economic turnaround.
Greek government bonds have also advanced strongly as the yield of the benchmark 10-year bond fell below 8 percent after ending the previous year at 8.57 percent. It stood at 11 percent at the end of June 2013 and was close to 11.90 percent at the end of 2012. More importantly, investors demanded a smaller risk premium to buy Greek bonds over German debt in the relatively thin secondary market. The risk premium separating the Greek bond from its German counterpart broke below 600 basis points earlier this year. The last time the 10-year yield spread fell to these levels was in June 2010, a month after Greece requested a bailout.
Of course the positive developments in the bond market largely reflect market euphoria about the prospects of the eurozone periphery after Ireland managed to sell 10-year bonds at low interest rates, and others, like Portugal, followed suit. Investors are growing more confident Portugal will be able to exit its bailout program next summer and Greece will make more progress on the fiscal front and structural reforms.
However, the excellent performance of Greek equities and bonds since the start of the year is at odds with the widely held view about a pickup in political risk as opinion polls show greater support for anti-bailout parties. Moreover, Alexis Tsipras, leader of the main leftist opposition SYRIZA party, has called for general elections if his party comes first in the ballot for the European Parliament in May. Given the two-party coalition government’s slim majority in Parliament – 153 out of 300 seats – a clear defeat of the two ruling parties at the ballot boxes next May could undermine the administration and lead to a protracted period of political uncertainty, many analysts and others reckon.
However, a good deal of foreign investors seem to hold a different view on the subject. According to them, the political risk is not as high as many analysts and others think, for two reasons. First, no mainstream Greek political party is in favor of the country exiting from the eurozone or has a plan for it. In their opinion, the main opposition party may be against austerity and other reforms, but it has no means of financing an expansionary fiscal program if it comes to power. Therefore, it will have to bow to the demands of the creditors sooner or later since they will be the only source of borrowing when it realizes the primary surplus is dwindling as spending rises and revenues fall on uncertainty. Past threats by SYRIZA officials about a moratorium on debt payments to provide the necessary funds are not thought to be credible since the adverse side effects on the Greek economy could be enormous.
A second reason foreign investors have taken such a sanguine view on Greek political risks relates to the position of the eurozone. In their view, the Greek public debt is passing more and more into the hands of official creditors, mainly the eurozone countries, which have naturally no interest in suffering the kind of direct and indirect losses a Greek exit from the euro would entail. In addition, a Greek exit could undermine the political project of the euro and do away with its irrevocability clause. Therefore, it is not in official creditors’ interest either to rock the boat, throwing more oil into the fire of political risk.
Of course, market participants sometimes make mistakes and they could be wrong about political risk this time around. If that’s the case, they will rush to correct their mistake and Greek assets, along with the economy, will feel the pinch. However, they have no reason to do so as long as sentiment about the eurozone periphery remains upbeat and Greece continues to make progress, primarily on the fiscal front.
Structural reforms may be important but yield fruit in the medium to long term and markets tend to overlook them, unlike policymakers outside the country. Under these circumstances, investors’ positive attitude toward Greek political risk should be taken seriously into account. After all, they put their money where their mouth is.