Advantages of issuing bonds under Greek law are there for the taking
European statistics agency Eurostat’s sharp upward revisions of the country’s deficit and debt figures have made debt dynamics more challenging and reduced Greece’s chances of accessing the international bond markets in 2011 or 2012. With the newly unveiled 2011 budget deficit target seen as difficult to attain in a weak economy, the government will have to go back and review its strategy and perhaps take advantage of the fact that Greek bonds have been issued under local law. As expected, the classification of 13 public corporations and organizations along with changes in the surpluses of social security funds, the recording of off-market swaps and an increase in accounts payables lifted the 2009 deficit to 15.4 percent of gross domestic product and helped push the estimated deficit to 9.4 percent of GDP in 2010. This necessitated austerity measures of more than 14 billion euros to cut the 2011 budget deficit to 17 billion euros from an estimated 22 billion this year, contributing to the decline of economic activity for a third year in a row. Coupled with consumer confidence being at an all-time low and weak public and private investment activity, the economy is now expected to shrink by 3.2 percent in 2011, making it more likely that unemployment will peak around 15 percent in 2012 instead of 2011. Even more important from private investors’ point of view, the public debt-to-GDP ratio was revised to about 128 percent in 2009 and is projected to rise to 159 percent in 2012. This definitely hurts sentiment and makes it more difficult for Greece to issue bonds in 2011 and even 2012. It must be noted that the country should have received 38 billion euros from the European Union – International Monetary Fund mechanism in 2010 but this will not be the case since part of the third tranche, equal to 9.0 billion euros in total, is expected to be disbursed in December and part of it – 6.5 billion euros from the eurozone – in early January 2011. The delay in the disbursement of the third tranche is widely seen as a message to Athens to comply with the terms of the memorandum signed between Greece and eurozone members and the IMF last May. Assuming the Greece complies, it is due to get 40 billion euros in 2011 and 24 billion euros in 2012 before the program winds down with 8 billion euros in 2013. By all accounts, the 2012 funding from the mechanism is not enough to fully cover the county’s borrowing needs that same year. Although market conditions at the time and Greece’s fiscal progress will play a role in convincing foreign bondholders to buy its new debt at reasonable yields, the high public debt-to-GDP ratio makes it less likely. However, to have a more accurate picture of the country’s debt dynamics, one should also take into account a few more factors. First, Greece’s GDP is likely to be revised upward at some point in 2011. The GDP was revised by 9.6 percent back in 2006 and is likely to be revised by a similar percentage this time around. Assuming this is the case, the debt-to-GDP ratio is likely to fall by about 10 percentage points. Second, 10 billion euros in debt has been earmarked for the Financial Stability Fund, which has been set up to as a backstop facility for Greek banks. If no bank uses the facility or taps into it and repays it by 2015, this amount will not count as part of the country’s public debt. It should be noted that 10 billion euros is equivalent to 5.5 percent of GDP. Thirdly, a good portion of the additional debt stemming from Eurostat’s revisions is owned by local banks, reducing the country’s reliance on foreign investors. Although the above adjustments make the debt-to-GDP ratio look less appalling, it is still very high. Moreover, given the country’s high borrowing needs of 70 billion euros or more a year in 2014 and 2015, it still makes debt dynamics look challenging. Some may disagree, considering it a sign of weakness, but the truth of the matter is that an extension of the repayment of debt owed to EU/IMF would smooth out the country’s refinancing needs over coming years. Still, Greece will have to seriously consider whether it should exploit the advantage of having most of its bonds owned by private investors issued under Greek law. Of course, it is better to enter into such discussions with your creditors when you run a primary budget surplus because you are in a better negotiating position. After all, you are able to more than cover your expenditures without including interest payments with your revenues. However, if you think you are unable to attain such an outcome in the foreseeable future, you may have to revert to the Greek law and take advantage of it. What we mean is very simple and seems to be the speculators’ nightmare on the credit-default swaps market. One buys these credit derivatives, called CDS, on sovereign debt either to bet for or against a country’s default or hedge one’s position against losses in case it defaults. Greece can, under local law, decide to heavily tax the coupons of existing bonds, making them less attractive to their holders in exchange for offering new bonds at a smaller nominal value, known as a haircut, which will be stipulated to be tax-free. Of course, this would require some cost-benefit analysis, especially with respect to its impact on the banking sector, but it could be done. The government should think very hard about taking advantage of having issued bonds in the past under Greek law to obtain a sizable haircut from existing private bondholders if it thinks a primary budget surplus is not feasible in 2011-2012.
