A policy marathon is looming and saving the economy is the prize

Greece may indeed manage to raise 5 billion euros from the markets via the syndicated loan of 5-year bonds, breathing a sigh of relief, but this does not mean it will have won the war. This looks more like a marathon than a sprint and will take some time, at least a few months, to convince the markets it will make it to the finish line. After a series of misjudgements that resulted in wider spreads across the yield curve of Greek bonds, the government decided at the suggestion of high-level bankers to do the sensible thing. Namely, to test the waters of global markets by issuing a 5-year bond via a syndication of banks, knowing it will have to pay a dear price for it. By all accounts, the government hoped the reception of the much-advertised, 3-year stability program would be warm enough to create some positive momentum which the country could take advantage of and raise a good sum of money by issuing new benchmark bonds. This was obviously not the case since a number of large international banks and credit rating agencies expressed doubts about some of the aspects of the stability program and certainly of its implementation. Under these circumstances, it comes as no surprise that Greek bond spreads over German bunds widened further with the widely watched 10-year spread exceeding 300 basis points. This is something not seen since last spring and before Greece entered the eurozone. Nor is it a surprise that the probability assigned to the country’s default on its debt obligations was no longer zero and some large hedge funds took speculative positions in favor of wider spreads by either shorting Greek bonds and/or buying Greek Credit Default Swaps (CDS). Some of them will be able to close their short positions by buying Greece’s new benchmark 5-year bonds, expected to be issued this week. Speculators are absolutely rational in taking these bets because they are aware of a dichotomy on the part of the Greek government. First, it is making the right noise about recognizing and resolving the problems. Second, it has little action to show because it is reluctant to deal both with the country’s potential liquidity problem in the short-run and its likely solvency problem in the medium-to-long-term. From the market’s point of view, the liquidity problem can be tackled through permanent measures to bring in more revenue and cut spending in order to convince markets that the 2010 budget deficit will be brought down to 8.7 percent from 12.8 percent in 2009. However, the solvency issue can be tackled by taking structural measures, such as the reform of the ailing social security system and opening up a number of occupations to competition. The markets realize the structural measures will certainly help reinforce the effectiveness of the restrictive budget measures but there seems to be no social consensus at this point. So, it is not surprising that some speculators dare to bet Greece may face technical default, that is, a situation in which the country seeks a rescheduling of its debt because it is unable to meet a payment. Being a member of the eurozone with total borrowing requirements of some 54 billion euros this year, this bet should have meant a sure loss. However, thanks to a number of mistakes on the Greek side, it has become a profitable one so far. It is perhaps even more important that we have come to the point where every financial «accident» by a Greek entity, be it the state, a bank or a large company, in the form of not making a due payment on debt owed to international creditors, will be increasingly viewed as a country credit event. In other words, an «accident» of this type suffices to convince more foreign banks to further cut their credit lines to Greek banks etc, depriving them of precious liquidity and making the situation worse. Under these circumstances, the success of the 5-year bond issue – in the sense of having more than 5-billion-euros’ worth of bids submitted – is important but it will not herald the end of the siege of the markets. It may simply turn out to be a lull in the battle but not the end of it. Of course, speculators and others are out there to make a profit, not to lose. So, it is up to the Greek government to make them change their mind and become its friends by placing bets in favor of tightening the Greek spreads over bunds, while convincing traditional investors that buying the bonds of a eurozone member at these generous spreads is a bonanza they cannot afford to miss. To do so, the government must become pre-emptive and more responsive to the demands of the markets. Even so, it will take at least a few more weeks and perhaps months for the country to get out of the big hole. Moreover, it will have stayed in the marathon race it is now running to reform the economy.

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