Greece moved to activate an EU-IMF aid package on Friday — and initial comments from analysts flew into the FT Alphaville inbox.
In the first instance, though, it’s worth pointing out that the news came as a bit of a surprise to the EU Commission, whose first statement after the request was simply (via Reuters):
EU COMMISSION SAYS HAS ONLY JUST HEARD OF GREEK REQUEST FOR AID
And promptly rushed out the following:
RTRS-EU COMMISSION SAYS HAS NOT YET RECEIVED GREEK REQUEST FOR ACTIVATION OF AID MECHANISM
RTRS-EU COMMISSION SAYS ITS DELIBERATIONS ON AID SHOULD TAKE A WEEK
RTRS-EU COMMISSION SAYS TO TAKE SOME TIME FOR GREEK AID TO BE TRIGGERED
As BNY Mellon’s Simon Derrick suggests, that’s hardly reassuring (our emphasis):
This morning has seen Greek Prime Minister George Papandreou formally request financial support under the joint European and International Monetary Fund loan package.
Although this was largely expected by the financial markets (given the muted reaction seen in both the EUR and the yield spreads), it is arguable that this might have caught the EU on the hop.
We note that it was only yesterday that EU economy commissioner, Olli Rehn said that he thought the request for aid would probably come in about two weeks time in order to allow the European Commission, the IMF and the European Central Bank to complete negotiations currently underway in Athens. Indeed, the latest comments from the EU Commission also suggest that they were caught by surprise.
And he goes on:
We clearly could continue producing remarkable statistics but, ultimately, they all tell the same story: the market believes that Greece will be forced to restructure its debt even when the bailout goes ahead (the EU Commission says that it is neither for nor against a restructuring). The logic of such a situation for investors is also simple enough: there is no last mover advantage in such a circumstance. Equally, we could point out the fact that, even now, the Eurozone seems to be getting caught just one step behind. However, these points are probably less important now than working out what happens next.
He also highlights the contagion problem, noting that Portuguese outflows are already beginning to be observed:
Although most other peripheral European market have remained relatively calm this week, it is noticeable that Portugal has started to find itself coming under a degree of pressure. The 10-year Portuguese/German yield spread hit 192 bp this morning (before coming back to 184 bp on the Greek announcement), comfortably breaching the March 2009 high.
Not only does this represent a 116 bp increase since the start of the year but it is also 8 times the spread seen when Portugal joined the EUR in January 1999. Moreover, it is not just the yield gap that has been moving. Yesterday evening saw the 5-year CDS on Portuguese debt close at 270 bp, meaning that the cost of insurance has doubled since the end of last month. Interestingly we also note outflows just starting to build from Portuguese debt in recent days (although they are still relatively modest). It seems clear which domino currently looks in danger of falling over on the European table. Maybe we now have an slightly idea which other domino might be hit if it does so.
JP Morgan’s analyst, meanwhile, notes the speed with which the activation has come:
This morning the Greek Prime Minister has stated that Greece will formally ask for the activation of the aid package that has been arranged in the past weeks between the Greek government, the European Union and the IMF.
Having stated that the mechanism could be activated before detailed negotiations with the IMF/EU were complete, the Greek request does not come as much surprise.
However, the speed with which the request has come reflects that the Greek authorities are being forced to respond to events as financial markets conditions have continued to deteriorate.
Although Greece does not need the funding itself until May 18th, the request is clearly designed to calm market conditions to some degree, while leaving time for necessary details to be ironed out before the funds are disbursed.
While many market participants are increasingly of the view that some form of debt restructuring will be part of the adjustment process, any proposal along those lines appears to be lagging behind the need to provide loans and calm market conditions in the near term. Focus will now shift to the speed with which the funds requested can be provided and the terms attached to them.
And Unicredit reminds clients the aid package still has to be approved by individual EU members:
Greece today has officially asked for financial assistance from the IMF and EU, and markets reacted with some relief, with spreads of Greek Government Bonds vs Bunds tightening by about 100bp at 2Y and about 50 at 10Y.
The Greek government had so far indicated that it hoped to be able to finance itself on the market, with potential IMF/EU aid as a confidence-boosting safety net. Markets clearly regarded this as unrealistic.
The official aid request is important in two respects:
(1) Markets believe that IMF/EU financing is at this stage essential to guarantee that Greece can meet financing requirements over the next 12 months;
and (2) an IMF program with its periodic monitoring will be essential to give investors confidence that Greece will carry out the necessary adjustment.
Over the last few days, there had been increased talk in the markets of the possibility of a debt restructuring down the line, even in the presence of a rescue package, with some observers arguing a restructuring could be seen as the baseline case.
This was extremely troubling, as there can be an element of self-fulfilling prophecy in this case, as fear of a restructuring inevitably keeps yields at elevated levels.
We have pointed out that Greece faces a formidable challenge in combining a draconian fiscal adjustment with robust growth, as both will be needed to ensure debt sustainability. This is an extremely hard task, especially given the lack of exchange rate flexibility, but not an impossible one. Greece has already committed to extremely serious fiscal adjustment measures under the 2010 budget.
The IMF program should now put in place additional detailed measures to underpin the planned fiscal adjustment over the following 2 years, as well as structural measures to make the fiscal adjustment sustainable and to boost growth potential.
We would now expect discussions with the IMF to be concluded within a couple of weeks, opening the way for approval of the program before the May 19th redemptions. Concrete progress on IMF negotiations should allow some additional spread tightening.
Beyond that, the first obstacle will be the official approval of aid by individual EU members, which in some cases might need parliamentary approval-we believe this should be secured in a timely manner, but it will remain a source of noise and uncertainty.
The focus will then shift to the implementation of the adjustment measures and the development of the growth outlook, with the IMF program reviews playing a crucial role. The challenge remains formidable, and the risks substantial; we expect Greece should get some benefit of doubt as the IMF program gets underway, but markets will remain nervous and will most likely require to see several months of track record of successful adjustment before becoming more confident that debt sustainability is within reach and a restructuring can be avoided.
In other words, we’re definitely not out of the woods just yet.
Related links:
Guest post: Mohamed El-Erian on the worsening Greek problem – FT Alphaville
The Germans and the Greeks – FT Alphaville
