Greece will have to concentrate on reducing its cost of borrowing
Greece is paying a high premium to borrow the money it needs from capital markets but this does not mean it must resort to the European Union or the International Monetary Fund (IMF) to lower it, as it seems to be doing. Instead, the country should bite the bullet and do the right things to reduce its cost of borrowing as soon as possible. The Greek government has argued that it is paying too much to refinance its public debt and fund its budget deficit needs, despite taking a series of painful economic measures to ensure a reduction of the budget deficit to 8.7 percent of gross domestic product in 2010 from 12.7-12.9 percent in 2009. Indeed, the country pays a premium of more than 300 basis points over Germany to borrow for 10 years, the highest of any eurozone country. We should remember that one percentage point equals 100 basis points. The Greek 10-year bond yielded 6.21 percent last Friday, compared to 4.20 percent for Portugal, the second-highest sovereign bond yield in the eurozone, and 3.95 percent for Italy’s 10-year bond, the third-highest yielding bond. The 10-year German Bund offered a return of 3.17 percent for anyone who bought it last Friday on the secondary market and held it until its maturity. This is a very large premium even if one takes into account that Greece has been assigned the lowest credit ratings in the eurozone by the three major international rating agencies: Standard & Poor’s (S&P), Moody’s and Fitch. We should note that there are other non-eurozone countries with lower credit ratings than Greece that borrow at tighter spreads over Germany. There is no question that the extra charge makes the country’s fiscal adjustment more difficult because of the higher interest costs on public debt it entails. Paying one percentage point more in interest rates on 10 billion euros’ worth of debt translates into additional interest payments of 100 million euros annually – no small amount for a country that is expected to borrow at least 35 billion euros more in 2010 to meet its borrowing requirement. However, one should not forget something else as well. First, investors demanded from Greece an interest premium of over 400 basis points over 10-year German bonds in early February. This means Greek 10-year bond yields have retreated by more than 100 basis points within a month or so. This has mainly been attributed to the announcement of the third austerity package by the government but also the supportive statements by high-level EU officials, which helped speed up the liquidation of speculative positions on local bonds. Secondly, Greece paid about 300 basis points over Germany to borrow via a 10-year syndicated loan in March 2009 but the spreads came in at about 125 basis points in August 2009. Although one may say Greece was not at the center of attention at the time and the recovery in international risk appetite at the time explains this development to a great extent, it shows the country could borrow at a much cheaper rate a few months from now, if it shows real progress in fiscal consolidation, the verdict from the major credit rating agencies is more positive and the clouds over Greek bonds’ acceptance by the European Central Bank (ECB) are removed. Although the economic recession may be worse than initially envisaged by the government, with the economy shrinking by 2 to 4 percent, it looks as if there is room for Greece to maneuver on the fiscal front to meet its budget deficit target. Although another downgrade by S&P cannot be ruled out, it would be foolish for anyone to assume than the ECB will not accept the bonds of a eurozone country as collateral for borrowing. This would amount to signing on the default of the country and it is not what central banking is all about. It should be noted that Greek bonds may not be eligible for ECB funding next December if Moody’s also assigns a B rating to Greece, as S&P and Fitch have done. The word from Bundesbank President Axel Weber, who is the leading contender to take up Jean-Claude Trichet’s post as ECB president, could not have been more clear a few days ago. Weber suggested the ECB could accept Greek sovereign bonds with a lower credit rating if the bonds were applied at a higher risk premium. Moreover, Greece will find out whether it will be able to borrow at cheaper rates once the risk of refinancing about 20 billion euros’ worth of maturing bonds and T-bills by the end of May is removed. All in all, Greece will be able to borrow at a lower interest rate soon, if the EU provides the much-talked-about standby facility of 20-25 billion euros at a reasonable spread, such as 200 basis points over the 10-year tenor, over Germany or the three eurozone countries with the lowest inflation rate, which is reminiscent of Maastricht criteria. However, the country does not really need the EU or IMF to convince markets of its ability to put its house in order and have the ECB do the sensible thing – that is, change its collateral rules on sovereign bonds for financing.