The deal reached at the emergency summit is being taken positively by markets largely because, after all the discord and fractures of recent weeks, the display of unity is a thing to behold. But looking beyond the current harmony, there are many issues still to overcome and on face value, the current proposal needs more work before it will stand any chance of bringing Greece and also the periphery onto a longer-term path of fiscal sustainability.
Making a few assumptions, then the sum of yesterday’s proposals will, over the coming three years, take the stock of debt outstanding back to levels seen around August of last year. This is something of a back-of-an envelope calculation, which does not take into account the underlying dynamics that will still be exerting upward pressure on the debt stocks as tax revenues continue to fall short of what is required. Even if nominal GDP was steady over the coming three years, then debt as a proportion of GDP would fall to only 143% by 2014, which again would not be dissimilar to levels prevailing a year ago.
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In sum, three years of austerity, improvements in loan provision and burden-sharing by the private sector would only get us back to where Greece was soon after the first bail-out. A week ago, the markets were discounting a 90% probability of a 40% haircut on Greek debt. This deal would cut the stock of marketable debt outstanding by around 8% (if the take-up was as anticipated by EU leaders). In other words, this is barely a fifth of what the market was demanding a week ago.
But then there is the question of to what extent the private sector wants to take part. Needless to say, there is a fair degree of uncertainty surrounding this, given the choices on offer. Investors appear to have the choice of three forms of debt exchange and one roll-over, although indications suggest that within these options there are different rates and durations on offer. The net result will be a lower interest burden and a longer duration of the debt stocks, which reduces the near-term burden of annual refinancing. From one angle, the deal appears favourable for banks (vs. market-led restructuring or bank tax) and there will be pressure for them to take part in the bond offers. At the very least, it will buy them some more time before a more substantial restructuring takes place.
The third key question is whether it provides sufficient ring-fencing around the other peripheral nations. Here we must look to the European Financial Stability Facility (EFSF) and the enhancements that have been made. It was last month that formal agreement to expand its scope so as to reach the intended capacity of EUR 440bn was achieved. Now the rules have changed substantially, involving the possible recapitalisation of financial institutions, intervention in secondary bond markets and the ability to act on a more precautionary basis. To achieve this, the current lending capacity looks thin.
In summary, this deal is only the start of a painful process. The private sector will have to take more of a hit at some point and the EU will have to pledge more money if the EFSF is to have the ability to instil confidence. It’s not the beginning of the end of the sovereign crisis, just another step along a painful road.
Simon Smith
Chief Economist
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