Beyond the rescue package, it’s now all about watching the fiscal cuts… and the bank vulnerabilities… and the financing needs.
So let’s look at the long-term task ahead for Club Med (plus Ireland).
As Barclays Capital’s Pietro Ghezzi and Christian Keller wrote on Wednesday:
The aggressive EUR750bn support package and the ECB policy actions announced last weekend can go a long way in addressing the financing and liquidity-related issues, thus lowering the risk of self-fulfilling dynamics, but it did not ease the task of successfully turning around debt dynamics. Going forward, we think this is likely to shift the market’s attention to the actual implementation of announced fiscal measures and also to the growth performance.
Or, in handy BarCap graphical form (click to enlarge, and yes, that’s a bubble chart):
Ghezzi and Keller have also tried to quantify the various sources of risk facing these sovereigns into one overall measure of vulnerability. Here’s the result, click to enlarge:
Which puts things quite starkly. However — the BarCap analysts’ main message is that each government’s debt risk profile differs in detail quite a lot, complicating the prospects for continued post-Greek contagion.
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Sorting out solvency
For example, on that issue of fiscal solvency, details do matter. Over to BarCap, emphasis FT Alphaville’s:
…Greece is in somewhat of a class of its own: it combines a very high debt stock at the start with a large negative flow (primary deficit) to correct. However, it also shows that relatively low initial debt ratios do little for solvency in a longer-term dynamic exercise, if the large flow imbalances (primary deficits) are not corrected. Both Spain and Ireland start off with much lower debt ratios than Greece, but also have large primary fiscal adjustment needs. If the adjustment is not implemented, their debt stocks could rise rapidly. That said, it cannot be ignored that – in spite of the longer-term dynamics – a relatively lower current debt stock typically provides more breathing room and could be seen as a signal that a country has managed to keep its debt under control in the past, providing somewhat more comfort about the ability to adjust in the future. This seems to speak in favour of Spain and, to a lesser extent, Ireland… [click to enlarge related charts below:]
…Portugal – often considered most similar to Greece – does start with better stock and flows than Greece. This implies less adjustment is needed, which, everything else equals, also implies a better chance of success. Overall, the results of our exercise seem to suggest that Portugal does not seem so much worse off than Spain. Therefore, from a pure solvency perspective, the large spreads between Portuguese and Spanish government bonds do not seem justified.
Spain rolled out much tougher deficit cuts on Wednesday, the WSJ reports, while Portugal has already planned extra adjustment worth 1 per cent of GDP. This left Goldman’s chief European economist Erik Nielsen very happy, in a Wednesday note:
A number of people have suggested that the availability of such substantial emergency funds and ECB purchases has been increased the risk of moral hazard, i.e. delayed fiscal action. I tend to disagree, and I think today’s fiscal announcements serve to suggest that the momentum now is indeed towards fiscal cuts, rather than the opposite. In other words, what we have in the Euro-zone policy space right now is “moral suasion”, not “moral hazard”.
Well, let’s see — especially as European Union officials make more noises about the ‘coordination’ of national budgets in the eurozone. There’s no smoke without fire.
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Of financing schedules…
Financing pressure in Europe’s riskiest sovereigns is also a bit unevenly distributed, BarCap’s analysts argue, making it hard to tell what’s coming up next in the crisis.
Creditor composition for each sovereign’s debt varies a bit, for example. Eighty-six per cent of Irish government debt is held externally, compared to just over fifty per cent for Italy. So Rome might fare better in rolling over debt and in fresh issuance.
…and bank stability
A fair enough point. Except ‘creditor composition’ should surely also include the extent of banks’ stakes in sovereigns — which is especially topical given the pre-bailout panic over who was exposed to Greece (and Greek banks). And, er, all too easily missed as a hidden aspect of government debt, via bank support programmes.
As BarCap argue:
Banking system health and the state of government finances are intimately linked and typically interdependent. A banking crisis can ruin government finances, and similarly, a sovereign crisis typically pulls down the banking sector as well. This probably makes the banking sector health the most important variable not directly included in the debt dynamics equation.
Ironically, Greek banks are not a systemic risk to Greece, given their small size and robust capitalisation (well, on Greek government debt). On the other hand…
Looking at the same measures for the banking systems in the other countries, the following pictures emerges: 1) Italy seems the closest to Greece – largely explained by the fact that, like Greece, mortgage lending did not play the same role as in Ireland and Spain; 2) Ireland and Spain seem the opposite of Greece, having the most vulnerable banking systems, perhaps most dramatically reflected in the surge of NPLs… and 3) in Portugal, some of the ratios appear somewhat better, but relatively high households indebtedness and lower capital adequacy ratios are weak points.
Italy seems to be consistently high and dry, then. But Europe’s sovereign debt crisis is due a few more scares yet, perhaps, in that this plethora of risks has now come out of the (er) Greek Pandora’s box.
Full BarCap note in the usual place.
Related links:
Europe’s Finance Firms Hold $78 Billion Greek, Portuguese Bonds – Bloomberg
Interest on PIIGS government debt – Long Room
Guest post: El-Erian on Europe’s ‘massive policy response’ – FT Alphaville
Greece and the issue of sovereign TBTF – FT Alphaville