Market tapping came late, not early
Greece won a battle but not the war against economic stagnation by accessing the international bond markets for the first time since 2010. However, the successful sale of the five-year bond could mark a significant turn in the economic adjustment program, improving the chances for GDP growth and leading to the country’s exit from the current form of financial assistance in early 2015. The exit should become a priority for the government and its official lenders since market discipline and the Fiscal Compact rules are also effective means of supervision.
We, like very few others, have been proponents of the country’s access to the markets much earlier than last week. As a matter of fact, we have been arguing in favor of such a move since last summer. In our opinion, the benefits of tapping the markets would have been greater than the costs, namely the higher interest rate paid initially on a small amount of loans. By picking the right time, the country’s earlier access to the markets would have improved sentiment faster, accelerated the decline of yields and helped more local corporations raise money in international markets. The latter would have made it easier for Greek banks to provide credit to other, smaller domestic companies. These are some of the positive side effects the government and the lenders expect from the sale of the five-year bond.
There is no doubt the sale of the five-year bond after four years in exile reflects investors’ increased confidence in the country but also their own calculations for a favorable yield-risk trade-off. The low comparable yields offered by other eurozone countries and the ECB’s determination to use even unconventional tools to battle low inflation contributed to this assessment. The Greek primary surplus, signs of economic stabilization, the absence of significant debt redemptions in the next five years and the expected debt relief measures from the EU minimized the refinancing risk in the eyes of the buyers.
However, the country still has a long way to go before it attains and maintains the high primary surplus to the tune of 4-4.5 percent of GDP from 2016 onward and annual GDP growth rates above 3 percent. The task is demanding and the high targets are vulnerable to internal and external shocks. Nevertheless, this does not imply the country should remain under the kind of strict supervision from the EU and the IMF it has been during the last four years.
Since the EU adjustment program runs out by year-end and the remaining tranches from the IMF are relatively small, ranging from 15 to less than 10 billion depending on 2014 disbursements, the government should look for ways to replenish the IMF loans with others. According to Nomura’s Dimitris Drakopoulos and Lefteris Farmakis, the bulk of the IMF loan incurs a large interest rate of special drawing rights (SDRs) plus 400 basis points. So, Greece is better off if it can get fixed rate funding from the markets at levels equivalent to three-month Euribor plus 400 basis points. It is noted one percentage point is equal to 100 basis points. From this point of view, taking on more IMF tranches does not help Greece’s cost of funding.
However, the country will also have to fill the funding gap of the 2015-16 period since this year’s projected gap of 4.5 to 6 billion euros is closed. The remaining gap could range from 6.5 to 8 billion, assuming no fiscal slippage but allowing for a smaller amount of privatization proceeds. Greece can close this hole if it can use part of the 11 billion euros allocated to local banks, but that implies the ECB’s stress tests in the second half of 2014 will not require local banks to boost their capital again in a significant way.
So, even modest market access to the tune of 5 billion euros per year or less in the 2014-16 period and the partial use of the 11-billion-euro reservoir can help Greece both fill the funding gap and stop adding more IMF tranches. This requires the consent of the EU so that markets are appeased and it would certainly be welcome by the coalition government because of its political resonance ahead of likely general elections in the spring of 2015. However, some may object to such as a development, arguing it will take pressure off the Greek side to implement more reforms and even encourage it to roll back others.
This is a valid argument if one takes into account the past behavior of the political elite and even during the height of the current crisis, but misses two points. First, Greece will depend on the markets, even for modest amount of funding. Investors are fully aware now of the Greek risk and will stop lending to the country if they believe it is behaving irresponsibly. In this regard, any government’s honeymoon with handouts will be short-lived and will be followed by a more painful period. Second, the country will still depend on the EU for structural funds, lower loans etc to keep on going. So it cannot act irresponsibly, at least for a long period because it will be penalized.
Therefore, the kind of troika supervision seen so far will have little to add to the implementation of the adjustment program, which is bound to end anyway. It will only play into the hands of anti-bailout forces. In our view, market discipline and adherence to EU fiscal rules will do better than the kind of troika supervision seen so far and the IMF visits to be continued from 2015 on if Greece does not stop taking on more loans from the Fund.
