Greece’s bond problems making borrowing more complicated
The acceptance of Greece’s three-year Stability and Growth Program by European authorities and international markets will to a large extent determine whether this year’s public borrowing plan will be implemented smoothly. This, however, should not stop the country from taking other measures to make its life easier and reduce its borrowing costs. Greeks have demonstrated repeatedly that they have the capacity to shoot themselves in the foot. As we have noted in the past, the derailment of public finances in 2009 is just one good example. Analysts who have knowledge of the workings of the Greek fiscal apparatus argue that the 2009 budget deficit could have been kept comfortably below 10 percent, perhaps even 9 percent of gross domestic product, sparing the country the ensuing bad press. By doing little in the last three months of 2009 to prevent the budget deficit from reaching 12.7 percent of GDP, a level similar to that of Ireland, which has seen its economy shrink by more than 6 percent in the last couple of years compared to a slightly positive outcome for Greece, the country invited trouble in the form of credit downgrades and worldwide attention. But Greece has shot itself in the foot in other ways, too. Thanks to its public borrowing policy of issuing medium- and long-term bonds since the start of the last decade, the country’s public debt has one of the longest average maturities in the Organization for Economic Cooperation and Development (OECD) and the second highest in the eurozone after Austria. The average maturity of Greek debt was around 7.8 years at the end of 2009, down from 8.5 years in 2008, but still high. The average duration of the debt used for managing portfolios was around 4.2 years – that is, close to the target of 4 years plus or minus 0.5 years. Some may think these are technical figures and they are right. However, they are also important figures. Why? Because they point to a low rollover risk as measured by the ratio of total redemptions to total debt. In fact, Greece’s is estimated at around 8.9 percent and is one of the lowest among OECD countries. To understand the importance of the above figures, one should bear in mind that the country would have had to refinance perhaps double the amount of some 20 billion euros in maturing bonds in 2010 if the average maturity of the public debt was much shorter, as in Italy and other highly-indebted countries. How many in the international media and markets are aware of these figures is not clear. We would bet not the majority, because Greece has not done a good job in disseminating this information. However, there is something else which is more important to the country’s efforts to reduce its borrowing costs. This is the liquidity premium embodied in Greece’s yield spreads over Germany or market interest rates (mid-swaps). According to bankers, it is not easy to find buyers of Greek debt when foreign players want to sell a good amount of bonds, leading to the widening of the sovereign spreads. Some of them point the finger at the local secondary electronic bond trading platform, which is not liquid in periods of market stress because the majority of primary dealers of Greek government debt are not active as they should be. Greece has assigned the status of primary dealer of its debt to some 22 Greek and major international banks. In an odd way, the liquidity of the secondary electronic bond system of the central bank tends to be satisfactory, meaning more than 1 billion euros’ worth of bonds change hands when things are calm – but this figure dips when things get ugly. Bond dealers contend this is so because some banks engage in trades between them at agreed prices when market conditions are calm. They are thus able to show they were active participants in the Greek secondary bond market so they meet one of the main criteria for being included in the list of primary dealers the following year. Needless to say, they tend to abstain when market conditions are tumultuous so they do not end up carrying more Greek bonds than they desire in their books. This situation has definitely contributed to the assignment of an unspecified liquidity premium to Greek yield spreads, which has made borrowing costs more expensive for the country. It is therefore paramount that Greece takes steps to correct this and reduce the liquidity premium embodied in its spreads by becoming more demanding of its primary dealers and more vigilant in monitoring their behavior. However, this requires a completely different approach to evaluating these banks and setting higher standards, including greater participation and the assumption of more risks on their part in the central bank’s secondary electronic bond trading platform. Of course, this is not as important as putting the country’s public finances in order. It is, however, an easy structural reform that has to be carried out.