Escalating Greek default fears rock Europe’s debt markets
by Ambrose Evans-Pritchard, Telegraph Online
Originally published 22 Apr 2010
GREECE’S DEBT CRISIS HAS REACHED A DRAMATIC CRESCENDO after the EU revealed that the country’s debt and deficit figures are even worse than feared and leading banks began to talk openly of debt-restructuring.
With contagion spreading across Southern Europe, spreads on 10-year Greek bonds exploded to almost 600 basis points over German Bunds in panic trading, pushing borrowing costs close to 9pc. Rates on two-year debt rose to 10.6pc in a market gone mad. “It is clear that the Greek situation is a very serious one,” said Dominique Strauss-Kahn, head of the International Monetary Fund. “There is no silver bullet to solve it in an easy manner.”
Credit default swaps (CDS) on Portuguese debt surged 50 basis points in a matter of hours to an all-time high of 270. Markit said the CDS on Spain reached a fresh record of 175, and Ireland jumped to 162, with jitters reaching Hungary, Bulgaria, Romania, Russia and even Argentina.
“This is now a real test of EU leadership,” said Julian Callow, of Barclays Capital. “Europe needs to act very fast to ring-fence Greece to prevent contagion. There has never been a default in Western Europe since World War Two and the whole financial system is depending on the assumption that it cannot be allowed to happen. There may need to be some sort of ‘Brady bonds’ or ‘Barroso bonds’,” he said, referring to the solution for Latin American debt in the 1980s. The Parthenon was closed to visitors, a symbol of the Greece’s paralysis as public employees carried out yet another general strike, this time as EU and IMF officials were holding their second day of tense talks in Athens.
Ilias Iliopoulos, head of the Adedy union, said the protest was a warning that calls for further cuts would meet resistance. “These bloodthirsty measures won’t help Greece exit the crisis. A tragic period begins,” he said. Greece is already squeezing fiscal policy by 6pc of GDP this year – cutting the deficit by 4pc – in the most draconian cuts ever imposed on a modern developed country.
Goldman Sachs said it is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months. Erik Nielsen, the bank’s Europe economist, said the rescue formula may evolve into a mixture of loans and debt forgiveness in order to give Greece “a much longer breathing space”. Any move is likely to be friendly. “I don’t think we are going to cross into the territory of forced debt restructuring,” he said. It is understood that EU officials are exploring formulae that would avoid triggering CDS default contracts, which could cause big losses for European banks that issued the derivatives.
City bankers are bracing for a possible haircut of up to 50pc on €270bn (£235bn) of Greek sovereign debt, hoping that any losses will be split between creditors and some sort of EU resolution fund. The trigger for Thursday’s wild moves was a report by Eurostat, the EU’s data agency, that Greece’s budget deficit last year was at least 13.6pc of GDP, and may be revised to over 14pc after a probe into “off-market swaps” and social security funds. Overall debt may be 5pc to 7pc of GDP higher than thought, pushing the total for 2009 to 122pc.
US rating agency Moody’s downgraded Greece’s debt one notch to A3 and warned of more to come. “The debt may stabilise only at a higher and more costly level,” it said. Moody’s rebuked the EU’s “fractious” handling of rescue talks and said the country would in any case need more than the €45bn of aid so far ear-marked by the EU and the IMF.
Germany’s ruling coalition is still sending mixed messages. The finance spokesman for Germany’s Free Democrats, Frank Schäffler, told Handelsblatt on Thursday that Greece should “voluntarily step outside the eurozone” if it cannot comply with austerity demands. “Any other way is frankly a placebo to calm the markets,” he said. The Greek media said the country may ask for a short-term EU loan before the full bail-out kicks in, though it is unclear how this could work. Nor is it clear what premier George Papandreou hopes to gain from delaying activation of the rescue mechanism, unless he is hoping to exploit fears of EMU-wide contagion to extract better terms. Athens is demanding a loan rate below the 5pc so far agreed.
Any talk of Greek restructuring is potentially dangerous. “It would cause massive [bond] spread turmoil in other peripherals if a troubled EMU member was not even given the chance to put its consolidation plans into practice,” said Marcel Bross, of Commerzbank. Suki Mann, of Societe Generale, said such a move would be a major headache for Portugal, Spain and Ireland. “In extremis, this could lead to debt restructuring in these countries too,” he said.
Data from the Bank for International Settlements shows that French-based banks have $75bn of exposure to Greek debt, and German banks have $45bn. Both countries are heavily exposed to Portugal as well. Northern Europe may have to agree to softer terms for Greek terms at the end of this poker game, or risk a banking crisis.