Yesterday’s note — sorry for the delay.

Greek Deal

A deal has been announced on Greece. There are a lot of points to make so I will put them as bullet points. The EU has bent over backwards to keep to the target of 120% debt/GDP by 2020 while also keeping to the PSI deal of a 50% nominal haircut (although both these numbers have slipped a little) and the figure of EUR 130bn for the latest bailout which EU leaders agreed in the autumn. This has not been easy, because the continued deterioration of Greece’s economy has taken it ever further from previous growth assumptions. I have marked with an asterisk the bending-over-backwards measures.

  • EUR 130bn will be disbursed in new bailout loans up to 2014. The IMF has said it will make a “significant contribution” to this, but has not given a figure. Christine Lagarde said that it would depend on the progress of EU governments in building their firewall (i.e. increasing or removing the lending cap on the combined EFSF and ESM; the IMF is in a good position to apply pressure here, since it has money that the Europeans want).
  • Greece is required to cut its debt/GDP to 120.5% by 2020.
  • *Interest margins on the original bailout loans are to be lowered.
  • The PSI haircut has been increased from 50% to 53.5% of nominal value and the coupon on new bonds has been reduced (to 2% for the first three years, 3% for the next five, and 4.2% thereafter). Investors will swap their Greek bonds for EUR 30bn of EFSF bonds and EUR 70bn of long-dated Greek bonds. These will be senior to any subsequently-issued bonds, something which may keep Greece shut out of international bond markets for a long time.
  • *The ECB is not foregoing future profits on its holdings of Greek bonds in the SMP. Profits on its positions will, however, be distributed to European governments (as a form of compensation for their having reduced the interest rate on Greece’s existing bailout loans).
  • *Greek bond holdings in the investment portfolios of national central banks will not be part of any bond swap. Profits will be distributed to the Greek government, however.
  • *Greek GDP growth is assumed to be zero in 2013 and over 2% in 2014, and to continue thereafter. This flies in the face of continued austerity and of experience.
  • A segregated account will be created for the bailout flows to ensure that Greece pays its debts before using money for general expenditure. This is a temporary measure; Greece has agreed to write into its constitution a requirement that the payment of debt take priority over all other expenditure.
  • Greece spelled out EUR 325m of further spending cuts that had been left unspecified, as the Troika had been demanding.
  • A permanent team of monitors will be installed in Greece.
  • Greece still has to do various “prior actions” by the end of February for the bailout to be signed off. These include the passage of a supplementary budget including spending cuts this year of 1.5% of GDP (EUR 3.3bn); cuts in the minimum wage of 22% for most workers and 32% for those under 25; the ending of automatic wage increases based on seniority; a reduction in social security contributions of 5%; and the opening-up of several professions.

Other significant points are as follows.

  • The Greek parliament plans next week to insert collective action clauses into its bonds in order to get the holdouts (bonds governed by English law may provide an opportunity here).
  • EU governments have yet to remove the cap on combined EFSF and ESM lending of EUR 500bn, but a number of EUR 750bn is being talked about and Germany has apparently dropped its objections to the idea. EUR 750bn falls short of the full EUR 1tr lending capacity that the combined vehicles could deploy if the cap were removed.
  • Greece’s banks are now expected to need EUR 50bn for recapitalisation, up from EUR 30bn.
  • Privatisation, which was expected to raise EUR 50bn by 2020, has been delayed five years (who wants to buy Greek assets today, except the bold? and is now expected to raise EUR 30bn by 2020.

Reuters and the FT have got hold on the assessment of European debt dynamics that was given to European leaders last week. Its baseline scenario shows Greece needing EUR 170bn over the next few years; a downside scenario sees debt/GDP rising to 160% by 2020 and a total bailout of EUR 245bn. Both scenarios look optimistic (, and the fact that a slight deterioration from baseline to downside causes such a large move in the 2020 debt ratio shows the fragility of the European plans. Significantly, the downside scenario is characterised as one in which various market reforms are delayed. In other words, the EU’s base case assumes rapid benefits to growth from liberalisation, which a) are not likely to be that rapid, b) may not happen at all given Greece’s political environment, and c) will not do much to help when the main problems are deflation and deficient demand.

What should we make of the latest plan, then? It is another short-term political fix. The actual solutions — fiscal transfers and stimulus, higher German inflation or Greek euro exit (a solution for the Eurozone, though it would not feel like a “solution” to Greece) — are nowhere near being tried. There is an element of pig-headed stupidity in this, particularly in the German belief that inflation is evil, always and everywhere. But there is also rational political calculation: ongoing fiscal transfers are the solution that would best fit the philosophy of the EU; northern populations are not ready to accept them; the debate is turning towards them, however, with the ESM soon to come into being and talk of euro-bonds refusing to die; and so politicians are applying short-term political fixes in the hope that the long-term solution that they consider acceptable will eventually become acceptable to their populations. Of course this is a simplification — every politician does not think the same way — but I think it captures the essence of what is going on.

What does this mean for trading? I remain of the view that the ECB has put the euro crisis on hold for the time being. Countries that are plausibly solvent — i.e. Spain and Italy — have been protected. That does not mean that they will not become insolvent as a result of austerity, or that the insolvent countries will not suffer further crises. However, for the time being, crises of the insolvent will be dealt with using short-term fixes. In this respect, the European crisis continues to follow the pattern I set out in August, whereby European politicians do just enough to stave of each immediate crisis but not enough to prevent the next one. Greece is fixed for now, in that a messy default is likely to avoided, and its economic disaster is not significant from a global point of view. Thus I expect the risk-on mood to continue.