Whilst some of us were glued to our TV sets last Sunday night watching “The Artist” cast trawl seven out of the 11 Bafta categories in which they were nominated, the Greek Parliament approved further austerity measures. These were in line with the troika’s request in its process to approve a second bailout package expected to be in the €130 - €145 billion region.
A deal for Greece will consolidate confidence in Europe- Vincent Micallef
The troika would have wanted cross-party support given that Greece is heading into elections, possibly in April, as it would not want one of the three main political parties (Pasok, New Democracy and Laos) to garner votes by opposing the adjustment programme and undo these measures once elected. The reforms include the immediate layoff of 15,000 public-sector workers, reducing the national minimum wage by 20 per cent to €600, pension cuts, and scrapping the habit of paying a “holiday bonus” equivalent to one or two months’ extra pay – hence the social unrest witnessed over the weekend.
Greece constitutes 2.4 per cent of euro GDP, an insignificant amount. So why is Greece so important to Europe? It is hoped that a deal for Greece will consolidate confidence in Europe, however failure will risk contagion risks in euro peripheral countries. The market seems to be trending towards a marked distinction between euro minnows Greece and Portugal, and their larger neighbours Italy and Spain.
The lower assumed risk means sustainable yields in the latter countries, giving the respective sovereigns more breathing space to get back into shape. Furthermore, leading economic indicators point towards a likely return to growth in Germany and the rest of the eurozone between Q2 and Q3 this year – good news for euro peripheries as their faltering domestic demand should theoretically be countered by higher exports.
Over the coming days, the terms of the private sector involvement in the Greek debt-restructuring saga should be finalised. The haircut on the debt was initially expected to be in the 50 per cent region, however it is more likely to be around 70 per cent as deterioration in the Greek economy (in part due to the strict austerity measures) means that Greece will not achieve a target debt to GDP ratio of 120 per cent by 2020. Two key issues remain the degree to which private investors will participate in the restructuring and how the ECB plans to recover the cost of purchasing Greek debt since the crisis began. The German Parliament would need to ratify disbursement, and the debt exchange must take place by early March, ahead of a €14.5 billion bond redemption on 20th March.
Some investors expect Portugal to be the next likely candidate to face major difficulties in managing its debt. With debt-to-GDP levels of 107 per cent, its sovereign bonds now rated sub-investment grade, Portugal has a fairly closed economy (gross exports make up 30 per cent of GDP – compare this to 100 per cent in Ireland). Although Portugal enjoys greater credibility than Greece vis-à-vis fiscal consolidation, the country suffers from structurally low growth. Ten-year bonds now yield around 11.5 per cent (16 per cent early February), indicating that Portugal will not be able to access the financial markets any time soon.
Spain last Friday passed labour market reforms, underlining the country’s impressive progress in combating this crisis. Spain makes up 11.5 per cent of eurozone GDP – almost twice as much as Ireland, Greece and Portugal combined. Unemployment in the country reached 23 per cent last month, and this is a major strain for public finances. The problem is more acute in the under-25 section where almost every other youth is without a job. The reforms include financial incentives to hire young and long-term unemployed workers whilst weakening the powers of labour unions.
Most importantly for Europe, these tough reforms could impress Spain’s euro partners who will be more inclined to help should the Iberian giant require. Germany made similar reforms in 2004 which transformed the country from a sick giant to Europe’s star performer.
Ten year Spanish bonds now yield circa 5.25 per cent (seven per cent plus just three months ago). Given adequate time, Spain might bear the fruit of the current reforms and have a greater chance of regaining market confidence for good.
On Tuesday, Moody’s cut the ratings of Italy, Malta, Portugal, Slovakia, Slovenia and Spain. Italy and Spain are now rated A3; Portugal Ba3. Malta was downgraded to A3.
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. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business. Should you wish to discuss this article in further detail, feel free to contact the author on 2342 6116.
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Mr Micallef is an executive director at Curmi and Partners Ltd.