Gov’t must tap markets immediately

Greece may need extra funding beyond the adjustment program’s projections in the next 10 months, despite a better-than-projected fiscal performance in the first quarter of 2013, largely due to likely bigger bank recapitalization needs. To avoid the bail-in of bank depositors, which would likely lead to the fall of the coalition government, the country will have to intensify efforts to raise as much money as possible from the markets. There are some encouraging signs, suggesting this is possible.

About three weeks ago, we argued Greece will have to take advantage of some favorable developments on the fiscal front and external accounts to tap the international capital markets in the second half of the year for the first time since 2010 and start building its yield curve. The latter, which is also known as the term structure of interest rates, depicts the relationship between market interest rates and the remaining time to maturity of debt securities. Auctioning 12-month treasury bills to mostly international investors would be a good first step in that direction.

Around the same time, Moody’s Investors Service put out a report saying the outlook for Greece’s banking system remained negative on still-high Greek sovereign exposures and most importantly on the continuous erosion of banks’ asset quality on the back of the deep and prolonged economic recession.

In the report, Moody’s central scenario assumed continued economic contraction and estimated Greek banks will need an additional capital boost of 8 billion euros, emanating from their loan book losses alone. This was after the sector’s recent 40-billion-euro recapitalization by the state-owned Hellenic Financial Stability Fund (HFSF), it noted.

The reference, which unsurprisingly did not get much publicity locally, coincides broadly with private estimates by some bankers and analysts, putting the figure between 5 and 15 billion euros. Normally, this should cause little alarm since the program has set aside some 50 billion euros for winding down and recapitalizing banks while banks can spare some capital via asset-liability techniques. However, some 10 billion euros from the 50-billion-euro pool appears to have been used to buy back Greek debt last December so there appears to be an issue. It is reminded the controversial buyback turned out to be a success, resulting in the reduction of the public debt by about 20 billion euros.

With the economy contracting more than projected in the last couple of years and unemployment surging to 17 percent, nonperforming loans (NPLs) have turned out to be bigger than projected by Blackrock’s diagnostic tests on banks’ loan books over the 2011-14 period. Bankers and analysts agree new diagnostic tests, incorporating recent data and assumptions about the economy, will point to larger capital needs. It is noted local credit institutions are implementing share capital increases to meet the capital adequacy requirements.

Government officials and others suspect the representatives of the creditors will ask for new stress tests when they return to the country next June. Some do not rule out that the state may need additional funding due to a hiccup in the economic adjustment program. But official creditors have made it clear there will be no new loans for Greece, so there are three options left if the country needs significant additional funding.

It can impose new austerity measures to enlarge the primary surplus or/and tap the international capital markets or/and bail in depositors. Imposing new austerity measures will be very difficult at a time the anti-austerity camp appears to be gaining ground in the EU and Greece has been administered an overdose. The bail-in option is not politically acceptable since it will likely lead to the collapse of the coalition government. Therefore, the more benign option is for Greece to raise the extra money from the capital markets. Of course, the country could also get an advance from the EU structural funds for the 2014-20 time span, but this requires the approval of its partners and may be accompanied with new conditions.

So the country may have to tap the international markets faster than some government officials envisaged just a few weeks ago. Local media outlets have reported the government had been aiming for 2014. In addition to help from fiscal data where revenues exceeded primary expenditures by almost 1 billion euros on a cash basis at the general government level in the first quarter, the government can take heart from listed companies tapping the bond market lately.

Hellenic Petroleum, in which the state has a significant minority stake, raised 500 million euros a few days ago by selling a four-year bond at an interest rate of 8 percent. The issue was oversubscribed six times, a sign of strong investor appetite at these high interest rates. Other listed companies are reportedly planning bond issues in the weeks ahead.

Of course, it may not be politically acceptable and economically sound for the state to borrow a good amount via a bond issue for a tenor of five to seven years and pay an interest rate of 8 or 9 percent. However, it may be feasible to do the same at a rate of around 7 percent and there are reasons to believe a window of opportunity may open at some point in the next four to five months.

Greece will likely need extra funding in the next 10 months to cope with bigger bank recapitalization requirements and a possible hiccup in the EU-IMF approved adjustment program. Since the country’s official creditors have ruled out the extension of new loans, the imposition of new austerity measures is a red flag and the government does not want to hear about a bail-in of depositors, Greece should follow the lead of listed companies and prepare the ground for raising some good amounts from the markets in the months ahead.