Global conditions test Greece’s search for 40 billion euros

Greece may need an expansionary fiscal policy to counter the recessionary forces from abroad next year, but it is mainly up to the buyers of its bonds to decide the extent to which the government can use budget deficit financing to soften the blow. There is no question the country is paying the price of inadequate structural economic reforms in the last few decades, illustrated by a high public debt-to-GDP ratio, large budget and current account deficits, an ailing social security system and a bloated public sector. These weaknesses usually become more apparent during a period of crisis and this is the case with Greece today. Based on current budget deficit projections and 2009 redemptions of public debt, Greece will need to raise about 40.5 billion euros next year to roll over maturing bonds of 26 billion euros plus additional bonds to finance the estimated budget deficit. Under normal circumstances, the country would have had no problem raising this sum, or even more if needed, on international debt markets at reasonable interest rates. But these are not normal times. Risk aversion among investors for all asset classes has peaked and some capital markets do not function properly. Government  bond markets continue to function but there are some warning signs even for short-term securities, widely regarded as the easiest to sell. The shrinking of the so called «spread investor» pool, that is, international investors who used to buy bonds of countries offering wider spreads over Germany or the money market – such as Greece and Italy – has contributed to this effect since there are fewer buyers for a larger quantity of government bonds.  The widening of the 10-year Greek government bond spread over German bunds and the five-year spread on the Greek CDS (credit default swaps) depicts the new reality. The five-year Greek CDS have set a new record, surpassing the 200 basis point mark compared to less than 85 basis points just a few months ago.   Investors also demand to be paid an extra 160 basis points over the corresponding yield on 10-year German government bonds to purchase 10-year Greek debt paper, compared to about 35 basis points in early 2008. However, this is more indicative of the strain in global capital markets and a uniform increase in bond yields paid by countries with weaker public finances than a purely Greek phenomenon. According to Gikas Hardouvelis, chief economist at EFG Eurobank, the widening of the 10-year Greek spreads over bunds is mainly explained by international factors and only a small portion, estimated at around 20 basis points, is explained by exclusively Greek factors. Moreover, the wider spreads over Germany are partly offset by the sharp drop of German bond yields. Greece would have paid a yield to maturity of 4.63 percent on its 10-year bond today compared to 4.30 percent in early 2008. So, in absolute terms, the rise in Greek bond yields is not big and one should bear in mind that the country paid even higher yields on some maturing state bonds. So, the main problem for the country is not paying wider spreads but raising the necessary funds at the same time that Greek banks are also using government guarantees to tap the global markets for bonds worth up to 15 billion euros. Greece must resort to international debt markets and try to place its 40-billion-euros-plus worth of bonds next year, but this will not be easy if markets are not functioning better by then. Bankers estimate international demand for local debt paper should be between 10 and 15 billion euros at this point but hope the situation will improve next year. If worse comes to worse, they say, the ECB may end up buying a high volume of Greek government paper; particularly if international demand does not suffice and local banks are called upon to shoulder the burden. In this case, they will buy the bonds and use them as collateral to obtain cheap funding from the ECB. Of course, nobody knows whether the ECB will be willing to essentially bail out the country. All-in-all, it is not so much the wider spread over German bunds that matters but Greece’s ability to find the money to satisfy its 2009 funding needs. This will determine the extent of any fiscal boost to the economy.