Wednesday, 1 June 2011

why the eurocrats think that re-profiling Greek debt will work.

I started off yesterday, with another post about Greece, it was boring....

digging through the numbers it just becomes so clear that Greece fudged its way into the euro. Greece ran a primary budget surplus of 3.62% before joining the euro, and then really just let it all hang out and since has been running -2.47%, whereas over the same period Germany ran 0.27% and 0.34% respectively.

Greeks' not paying high real net tax rates is not a new thing, preEuro (pE) tax revenues as a % of GDP, 39.64% versus aE 39.21%. So it really is the spending side of the equation that has made all the difference; going from 36% to 42%. ie having a Northern European welfare state, but also low taxation, and plenty of EU funds.

It has been incredibly puzzling that European ministers believe that reprofiling will sort out what I believed, like other commentators, to be a solvency crisis.

After the 90% net debt to GDP, its a when not if case of default, and lets call it default not modification, restructuring, etc.

Banks might be willing to pretend that a reprofiling (ie saying you can have your money back in 20yrs rather than 10yrs) is not a default, but a zero coupon german government bond would go from 71 to 51, a 30% haircut. Banks that have this crap in their "banking book" should still be able to pretend that there isn't a loss.


can Greece reach a stable equilibrium without default?

In eurocrat world, the answer has been muddled.

Under what parameters does Greece avoid blowing up?

Its current interest payments/total debt outstanding gives us the average interest rate which stands at 3.83%. Germany at 2.87%, so the credit spread that Greece "feels" is only 130bps. Even at that low level it was forced to ask for aid.

Believe it or not, it managed to feel a credit spread of only 56bps on average since joining the euro, instead of the 329bps before.

IF Greece were to reprofile, in terms of modelling that is just a guaranteed rollover of a bond into a longer maturity with the same coupon. BUT given that Greece is having to borrow to meet its coupon payments at the moment then it will still see some uplift in its effective average interest rate, unless it is given even greater access to EU funds.

So lets assume we lose our minds, and give the Greek government a pass, and assume they can bring their primary budget balance to a pre euro surplus of 3.4%, and that they have strong nominal GDP, what is the interest rate that avoides them spiraling out of control and needing to default. Well it looks like at about 600bps credit spread is the cut off point, above that and Greece is bust, below that it *could* turn its self around, if the Government managed to turn a 4% primary budget deficit into a 3.5% surplus over a few years, with very high economic growth. THIS IS WITH REPROFILING...

without reprofiling....then that stable credit spread is only 450bps.

assuming the market lost its mind and allowed Greece to roll its credit at current spreads, in less than 5yrs half of Greece's increased tax revenue would be spent paying the interest alone.

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