Greek Theater

Story Highlights:

• Greece’s higher-than-expected budget deficit at the end of 2010 currently puts the country off track to meet its austerity agreements.
• Recently, yields on longer-term Greek government bonds rose to record highs—and chatter is heating up over possible Greek debt restructuring.
• While possible, we see near-term restructuring as unlikely because it could undermine the stability of the currency region—something union members rationally wouldn’t want.

The Greek debt saga continues this week. Eurostat (the European Union statistics agency) reported Greece’s budget deficit was 10.5% of its GDP at the end of 2010—not the 9.4% forecasted in earlier estimates. This currently puts Greece off track to meet the austerity agreements outlined in its €110 billion fiscal bailout—placing the scheduled June disbursement at risk.

Greece blamed low tax receipts and entitlement obligations for the higher 2010 deficit. Not surprisingly, yields on longer-term Greek government bonds rose to record highs, and spreads on Greek credit default swaps widened. Additionally, chatter is heating up over possible Greek debt restructuring.

It’s estimated Greece has a debt burden of about €340 billion (~$500 billion). A restructuring could be conducted any number of ways, but two scenarios seem likeliest. One would be to establish a “eurozone trust”—possibly using the European Financial Stability Facility (EFSF) or European Stability Mechanism (ESM)—to buy Greek bonds and extend the maturities or retire the debt at a loss (effectively a haircut). The other would be something akin to the “Brady Bonds” plan used to help resolve the Latin American debt crises of the 1990s. In this scenario, bondholders could swap their Greek bonds for new bonds guaranteed by the greater perceived safety of the eurozone or by the EFSF/ESM.

However, we see near-term restructuring as unlikely at this point. Restructuring now would undermine the EFSF’s promise to support eurozone debt until 2013 and, in turn, the stability of the currency region—which EMU members no doubt know and rationally would want to avoid. Bond markets also appear to be suggesting restructuring is unlikely in the near term, with short-term yields remaining relatively tame (though yields sharply spiked for bonds with maturities of two-plus years—after the conclusion of EFSF). What’s more, since the extent of Greece’s woes came to light last year, EMU members have shown their commitment to maintaining the union, at least in the near term (though some have dragged their feet to varying degrees and harrumphed). We don’t see that as changing this year or next (neither the commitment to the union nor the occasional harrumphing).

Plus, despite Greece’s deficit being higher than expected, it’s still lower than 2009’s 15.4% deficit, showing some progress. So to us, the most logical option is for the EU/IMF to continue providing Greece financial support for now—giving Greece time to grow and pay down debts.

In the longer term, Greece’s course is far from clear. Portuguese and Irish yields also hit recent highs following Eurostat’s report, reflecting investor jitters. But, of note, Spain and Italy have held successful debt auctions lately with robust demand, showing not all PIIGS are trending the same in investors’ perceptions. Stay tuned as European officials meet in Athens early June to further review the drama in the Greek theater.