Greece will have to create the right conditions to win back the financial markets if it wants to return to a sustainable growth path. This means it has to present a credible investment story that combines fiscal discipline with privatizations and some structural reforms in addition to political stability, among others.
Greek bonds and stocks rallied in the second half of the 1990s, discounting the country’s nominal convergence with the rest of the European Union countries. The sharp drop in inflation on the back of fiscal tightening, culminating in primary budget surpluses for several years, pulled down yields to single digits and allowed the country to issue medium- and long-term bonds.
The so-called Greek convergence trade produced tremendous trading gains from bonds to local and international banks, funds and individuals. The end result was to boost market sentiment vis-a-vis local assets and the prospects of the Greek economy, creating a virtuous cycle. Stocks also had their heyday, producing incredible returns and leading to a bubble that eventually burst. The story behind the outperformance of Greek stocks and bonds that fed into economic activity was Greece’s prospective entry into the eurozone.
In the first few years of the first decade of the 21st century, Greek stocks and their holders suffered sharp losses as prices descended to more reasonable valuations after the bubble. However, the Athens bourse staged a rally, spearheaded by bank shares, from the spring of 2003 that took it into 2007. The story behind this rally was the superior growth rates of the Greek economy compared to its counterparts in the eurozone and the prospects from the local banks and other companies’ expansion into emerging economies, mostly in the Balkans.
Greek bonds benefited mostly from the country’s entry into the eurozone and the low interest rates as markets mistakenly assumed membership in Economic and Monetary Union (EMU) led to a convergence of country risks toward Germany. This explains why the spread separating the 10-year Greek bond from its German counterpart fell to less than 25 basis points at some point. Readers are reminded one percentage point equals 100 basis points. The country’s high GDP growth rates and contained inflation also helped. Of course, everything fell apart after the international credit and economic crisis in 2007-08.
Overall, the growth story, encompassing international expansion and low inflation, was the driver behind the Greek stocks’ strong performance and the bonds’ good performance, at least partially.
Unfortunately, the country has failed to put together a convincing story since then to help attract foreign investors into bonds and stocks, boost business sentiment and pave the way for direct investments in order to brighten the country’s economic prospects. What we have witnessed since is efforts to present a sectoral story. That was the case with the four systemic banks in the two previous recapitalizations in 2013 and 2014. The story relied mostly on the benefits from synergies, following a number of mergers with other domestic banks, and their capacity to turn bad loans into “good” ones as the economy exited recession. This sectoral story was bought by foreign funds and translated into more than 8 billion euros in fresh capital.
The prospect of economic recovery and the noticeable progress in producing primary surpluses and implementing some structural reforms underlined the bond rally over the same period. It culminated in Greece’s return to the markets in April 2014 for the first time since it signed the bailout agreement in 2010. The rally also helped some large Greek corporations to tap the international bond markets for a few billion euros, reducing their dependency on the local banking. sector and increasing their ability to refinance expiring debts and funding some investments.
The latest attempt to tap the markets was the recapitalization of the core banks. The four banks were able to raise more than 5 billion euros in total in fresh capital with an unspecified but good chunk coming from Greek investors and businesses. Talking to foreign funds, one can see why some of them decided to participate despite the country’s high risk. According to them, the valuations of the Greek banks were much lower this time than last time around. The price-to-tangible book of the banks was estimated at between 0.3 and 0.4 compared to 0.8-1.1 at last year’s recapitalization. In their eyes, this translated into limited downside risk but unlimited upside risk if the banks effectively manage their bad loans.
The same foreign funds bet that the recapitalization of the banks and the completion of the first review of the third bailout agreement signed last August will make it possible for the ECB to accept Greek bonds again as collateral in its refinancing operations. This will help lower the banks’ funding costs, boosting their profitability, but it will also help push Greek bond yields lower. The latter will have a beneficial effect on Greek stocks by making their valuation more attractive. The same argument holds for other local assets, such as real estate, which may be put up for sale.
All in all, Greece has yet to articulate a credible investment story to be able to attract billions of euros in much-needed foreign investments to help boost its economy. The argument, which stresses attractive valuations, may work in some cases and for some time but it does not constitute a solid story. This is more so when concerns about geopolitical risks are on the rise. The country has to find a new, convincing investment story. Political stability, fiscal discipline and privatizations should be part of it.
[Kathimerini English Edition]