Premier may be shifting blame due to possible need for more measures

Prime Minister George Papandreou’s hint that Greece might turn to the International Monetary Fund (IMF) for aid if the EU fails to come up with a similar package on March 25-26 have caused alarm in some EU capitals and anger in others. Some even think it was a misplaced bluff called by the Germans. Even so, Papandreou’s tactics may reflect something he would not really like to make public. It is rare for a country with a heavy borrowing schedule to miss an opportunity to raise a significant amount of money and reduce its refinancing risk but this is exactly what happened last week. The Greek government chose to close the window of opportunity created by the decision by Standard & Poor’s to take the country out of its credit watch for another downgrade last week and tap the international markets, pinning its hopes for cheaper funding on the outcome of the upcoming EU Summit and/or the IMF. This is quite surprising for a country that took a number of draconian economic measures just a few weeks ago in its bid to cut the budget deficit to 8.7 percent of gross domestic product (GDP) in 2010 from a whopping 12.7-12.9 percent of GDP last year and continue to have access to world capital markets. The fact that Greece easily sold 10-year bonds totalling 5 billion euros to international investors via a syndicated issue on March 4 confirmed that it would have had no problem raising the funds at the prevailing spreads and interest rates. The Greek 10-year bond paid some 326 basis points over the German bond that carries a coupon of 3.25 percent and expires January 2020. On the heels of the successful sale of the 10-year bond and the positive reception of the third austerity package, Greek securities staged a mini rally which brought down the 10-year yield spread over Germany some 20 to 30 basis points and even more in shorter maturities. These spreads were compressed even further when S&P’s removed Greece from its credit watch list, confirming its «BBB+» credit rating although it maintained the «negative outlook.» The widely watched 10-year spread over Germany fell close to 290 basis points, yielding about 6 percent compared to 6.40 percent at issue on March 4. Although there was an official proposal that the country tap global markets and raise a significant amount ahead of expiring bonds and T-bills worth some 20 billion euros by end-May, the government decided not to do so, pointing out the spreads were still too high and «unsustainable.» Even though no one doubts that the high cost of funding increases future interest payments and makes fiscal consolidation more difficult, many pundits still wonder what the Greek prime minister is up to. This is so because it is quite unusual for an EU leader of a country in a difficult situation to issue an ultimatum to his partners to come up with an aid package in a week or so or the country will turn to the IMF, knowing that this may hurt the euro and the Eurozone’s international image. Some understandably thought Papandreou was bluffing to get the best possible deal out of Brussels. That’s why they thought Germany called the bluff when German officials suggested that Greece go to the IMF. Although one may agree with this interpretation, there may also be something else in Papandreou’s mind that can help explain all these confrontational tactics aside from having miscalculated the situation or genuinely believing that the high cost of funding, assuming it is maintained at current levels, will derail fiscal consolidation. One should not rule out the possibility that the Greek prime minister believes the austerity measures taken so far may not suffice to attain the budget deficit targets set in the three-year stability program. He may also think it is politically untenable for his government to take more austere measures in the future and is trying to get out of this dilemma by shifting the blame elsewhere. It is worth noting that the Greek budget deficit will have to fall below 3 percent of GDP in 2012 for the public debt-to-GDP ratio to start coming down. If this is correct, it is reasonable to expect that Greece will continue to borrow at elevated levels in months and even years to come. Of course, under normal circumstances, Greek yield spreads should have gradually started to decline. All-in-all, the Greek prime minister’s hints at the IMF solution if the EU does not come up with an aid package on March 25-26 may reflect the view that the budget deficit targets set in Greece’s three-year stability program are hard to achieve, making a market-induced de-escalation of Greek spreads more difficult and slower. In this regard, an aid package involving the IMF will help provide cheaper funding and help shift the blame elsewhere.

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