Even if the interest rates charged by Europe’s Financial Stability Facility (EFSF) are lower than we thought they would be, they’re still counterproductively high.
Here’s why, from CreditSights (our highlights):
At the end of 2010, Greece’s average interest cost was around 4.1%, the interest expense was €13.3 billion. The weighted average coupon on the two-years and longer bonds is 4.6%, equivalent to an annual cost of €11.4 billion. If Greece is able to borrow at the same rate as Ireland’s 5.7%, buying back half the two-year plus debt at a 31% discount to par would push up the average interest rate on longer-dated debt to 5%, but reduce the interest expense on that part of the debt to €10.6 billion…
But if the expected budget deficits and the debt that is due to mature between now and the end of 2012 is also refinanced via Greece’sbp on top of three-month Euribor plus a 50 bp upfront service fee), then the average cost of the debt will rise back to 4.6% from the current 4.1%. Assuming Greece balances the budget deficit by 2013, nominal GDP will need to grow by 4.6% to stop the debt-to-GDP ratio from snowballing EU-IMF programme at the existing short-term rate (300 . The official nominal GDP growth estimate in 2013 is 2.9% and for 2014 it is 3.3%.
Unless the Greek government can start generating a budget surplus of 2.2% of GDP in 2013 the debt is going to continue to snowball. The official forecast is for a budget deficit equivalent to 4.9% and that does not incorporate an increase in the interest expense. It is noteworthy that Greece’s primary budget is expected to be roughly balanced by 2013, lending support to the idea that tackling the maturity and the interest rate might not be futile …
We hear that this kind of interest rate reduction is being pushed by quite a few eurozone consulting types — and as quick and dirty fixes go, it’s not half-bad. Though it’s worth remembering at this point why they were at that level in the first place.
Bank of America Merrill Lynch’s Ralf Preusser has a nice explainer:
3. Lower interest rates
What is it: The interest rates charged to Greece and Ireland by the EU are punitive both relative to the funding costs of the creditors, and relative to the historical funding costs of both countries. These interest rates also do not meaningfully lower the default probability. Lowering the rate charged to countries applying for aid should support debt sustainability measures and therefore directly affects solvency calculations.
What is required: Changing the interest rate charged on EFSF loans is a decision to be taken by the EFSF and the guarantor countries but would likely not need parliamentary approval. Advantages: Significant improvement in debt sustainability measures. No parliamentary approvals required. No cash outflow.
Disadvantages: The rationale for the punitive interest cost has been the desire not to present the EFSF as a bail-out in the context of the Maastricht treaty. Lowering the interest charged significantly could increase the chances of success for the plaintiffs in Germany’s constitutional court that challenge the legality of both the Greek package and Germany’s participation in the EFSF. Significantly lowering interest rates may also induce other countries facing high funding costs to apply for support, though so far the political costs of doing so seem so high, that this should be considered a low probability event.
Probability: High
Market impact: Positive for those countries receiving loans, neutral for the rest.
Ralf’s even got a handy table of the various ways in which the EFSF might be tweaked — including maturity extensions and those controversial debt buybacks.
In the meantime though, both CreditSights and BofAML figure there’ll be quite a lot of volatility amidst eurozone peripheral debt until the EFSF is sorted out.
Related link:
Fix the EFSF – lose the triple A? - FT Alphaville
Europe’s EFSF really is not saving anything – FT Alphaville
SPVery complicated in Europe – FT Alphaville