Although still early days, plan B on debt restructuring may be taking shape

The markets continue to doubt Greece’s ability to avoid the restructuring of its public debt in coming years despite cutting its budget deficit by 39 percent year-on-year in the first seven months of 2010. Although both the European Union and Greek officials vehemently reject the idea of restructuring, some senior bankers and other market participants think the EU and the International Monetary Fund must be thinking about or even preparing a plan B for Greece. It was not a good week for the debt paper of the fiscally weak eurozone countries last week. Concerns about the so-called peripheral countries intensified despite a spate of successful bond auctions. Ireland’s downgrade by Standard & Poor’s reminded everybody of the risks facing the countries with the most precarious fiscal positions, including Greece and Portugal. Credit markets pushed the spreads on Irish credit default swaps (CDS) to record highs while spreads on 5-year CDS bought by investors to insure against a possible moratorium of payments on Greek state bonds jumped to well above 900 basis points, according to data from Markit. According to the optimists, we should not read too much into these numbers because it is still too early to render judgment since Greece is just a few months into the program and has already made progress in cutting its budget deficit and adopted some structural measures seen boosting the competitiveness of the economy in the long run. From this point of view, one has to wait until next February, when the official figures about the size of the 2010 budget deficit will be out, to make a wiser decision as to whether the country can avoid restructuring its public debt in the coming years. Assuming it cuts the deficit to 8.1 percent of gross domestic product in 2010, it will gain market credibility and see its spreads come down considerably, paving the way for returning to the markets with a bond auction in the second half of 2011. However, not all are convinced by these arguments. The pessimists point to the extraordinary level of the 10-year yield bond spread separating Greece from Germany, sitting above 900 basis points, as an indication of the markets’ unwillingness to lend Greece money at reasonable spreads. They argue that even if the country satisfies the requirements set in the economic program agreed upon with the IMF and the EU and Greek yield spreads over Germany come down considerably, the country will not be able to borrow at yields any way near the 6.0-6.5 percent range for 10 years as it did last March. They say the risk premium required by global investors to buy Greek bonds, if any at all, will be very high with the country’s public debt-to-GDP ratio well above 130 percent, even after allowing for an expected upward adjustment of GDP in 2011 and without taking into account the uncertain effects of austerity on growth. It may be too early to suggest which side is right or wrong. However, some market participants from both sides seem to suspect that the EU and the IMF must be thinking about or preparing a plan B for Greece given the maturity profile of its public debt in coming years. According to IMF estimates, Greece will have to borrow some 313 billion euros during the 2011-15 period. The country’s borrowing needs are put at about 55 billion euros in 2011, about 58 billion in 2012 and 53 billion in 2013. However, they go up to 70.7 billion in 2014 and 76.6 billion in 2015, when the country has to repay its loans to the EU and the IMF. The market participants who think the EU and the IMF have no choice but to work on a plan B for Greece argue that the amounts, especially for 2014 and 2015, are staggering. This plan B is likely to involve a new aid package in the future according to them. They admit the EU and the IMF will be able to sell the new package to their members more easily if Greece has made progress in its fiscal consolidation and structural reforms. What could this plan B be all about? Some think it may involve the extension of the maturities of Greek bonds bought by EU countries and the IMF to help lower the country’s borrowing requirement to manageable levels in coming years, especially 2014 and onward. This does not constitute a credit event as would have been the case if Greece had asked private investors to do the same and therefore has no effect on Greek CDS. Others think it may involve a new package of structural funds from the EU to help the Greek economy grow, facilitating the repayment of its creditors. The latter may supplement the partial roll-over of Greek debt in the coming years. It is not unimaginable to think that some in the EU or the IMF may be already thinking about such a plan B for Greece even though they may deny it in public. Nevertheless, it is also safe to say the acceptance of such a plan B would be more likely on the part of eurozone countries and the IMF if Greece were alone in needing help so that the amount of money required was manageable and the international economic environment was benign. It is reasonable to assume all bets would be off if the global economy fell back into recession but this is not the baseline scenario at this point. Therefore, the case for a plan B should not be taken lightly. Even though it is relatively early to talk about it, it is not too early to start thinking about and planning it.

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