Greece’s financial woes

Last week, the Greek Parliament voted in favour of the Medium Term Fiscal Strategy bill. The austerity package involves a wide array of measures which will hit most Greeks. Ian Bremmer put this succinctly in a recent Financial Times article: “… it offers a little something for everyone to hate”.

These measures include: A solidarity levy of one to five per cent of household income and lowering the tax-free threshold for income tax from €12,000 to €8,000; Higher property taxes; VAT rate increases of one to four per cent; VAT for restaurants and bars will rise from 13 per cent to 23 per cent; Luxury levies on yachts, pools and cars; Increasing excise taxes on fuel, cigarettes and alcohol by one third; Nominal public sector wages to be cut by 15 per cent and those of state-owned enterprises by 30 per cent; Raising the statutory retirement age to 65, whilst one would be required to work for at least 40 years to be eligible for a full pension and benefits.

The vote was essential for Greece to receive the second tranche of the €110 billion bailout agreed by the EU and IMF last year, and to avert a default on a sovereign debt pile of €340 billion – more than €30,000 per Greek citizen.

The debt is equivalent to 150 per cent of Gross Domestic Product; according to the Maastricht Treaty the ratio of gross government debt to GDP must not exceed 60 per cent. Why is Europe so keen for Greece not to default? In a nutshell, a Greek default would hit banks that hold Greek debt, including the European Central Bank. Jean-Claude Trichet, ECB president, stated on numerous occasions that any restructuring of Greek debt would have to be voluntary “to avoid serious consequences.” Default will trigger credit default swaps, instruments which provide insurance against an issuer reneging on its dues, while there are already signs of a credit freeze similar to when Lehman collapsed three years ago, when banks virtually stopped lending to each other.

Furthermore it could create bank runs, contagion to other countries such as Ireland and Portugal, and at a stretch, the crumbling of monetary union. The ECB has asked for the involvement of the private sector to supplement ECB/IMF aid – mainly revolving around a resolution by the European banks and other financial institutions holding Greek debt. Deutsche Bank’s CEO, Josef Ackermann told German Chancellor Angela Merkel in a conference last week that financial institutions would offer a hand in the solution “not because we’re doing it gladly, but actually to enable policymakers to do something… so that we don’t have a meltdown.”

A number of proposals have been discussed to restructure Greek bonds, at the same time avoiding credit rating agencies declaring the European state to be in selective default. The one which is receiving most prominence, and which will probably serve as a blueprint for other financial institutions, is one put forward by the Federation Bancaire Francaise, dubbed the “French Proposal”. FBF is suggesting two options, specifically targeting bonds maturing over the next three years:

Option 1: Rolling over a minimum 70 per cent of maturing principal into new 30-year bonds, receiving cash for the remaining 30 per cent. The coupon on the bonds would be tied to Greek GDP growth, offering a minimum of 5.5 per cent p.a. and a maximum of eight per cent. Greece would then use 30 per cent of funds to purchase 30-year AAA-rated zero coupon bonds to act as collateral on the principal of the new bonds.

With Option 2, participants invest a minimum of 90 per cent of the maturing capital in new five-year bonds bearing an interest rate of 5.5 per cent. German institutions are discussing rolling over around €30billion nominal of bonds maturing until 2020.

One should note that Standard & Poor’s quickly stated that any debt rollover, even if voluntary, may place the country into temporary ‘selective default’. This would be a major problem, particularly for Greek banks whose only means of credit currently is by borrowing from the ECB against Greek debt. The ECB would not normally lend against defaulted bonds, however earlier this week it suggested it will continue to accept Greek debt as collateral unless all the major credit rating agencies (Fitch, S&P and Moody’s) declare Greece to be in default.

Greece’s debt is unsustainable, but the EU seems to believe that lending them more money will buy them time to effect necessary changes. Surely, we will be hearing more about this news item over the coming days, week and months – in fact the issue is evolving as we go to print. One would assume that countries such as Portugal and Ireland would be watching Greece’s experience very closely.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Some of the opinions expressed here above are of a forward looking nature and should not be interpreted as investment advice, nor should it be considered as an offer to sell or buy or subscribe to any investment vehicles or strategies that might have been mentioned in the article. The company and/or the author may hold positions in any securities that might have been mentioned in this report. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.

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Mr Micallef is an investment executive at Curmi and Partners Ltd.