Greece: Exploding the myths
11 December 2009
The past week has seen rating actions on Greek government debt from two of the three major rating agencies. Fitch downgraded Greece’s sovereign credit rating by one notch to BBB+, and maintained a negative outlook. S&P, meanwhile, put Greece's A- rating on negative watch. And although Moody’s has not moved in the past week, it had already put Greece's A1 rating on review for possible downgrade at the end of October.
These rating actions triggered a sell-off in Greek government debt, with the selling compounded by concerns that Greek debt will no longer be eligible collateral in ECB refinancing operations come 1 January 2011. From that date, collateral will need to be rated A- or higher, and maybe by at least two of the three agencies. Yields have risen sharply across the curve (see chart), with short bonds suffering most – 2Y yields have risen by over 120bps in the past week alone.
Greek sovereign debt yields
Source: Bloomberg
These developments have prompted plenty of excitable commentary, ranging from the prospect of an imminent Greek default to the break up of the euro area, with Greece (and maybe even Ireland) being forced to leave the single currency. But amidst all the hysteria, what are the facts?
Never the healthiest, the Greek public finances have deteriorated massively over the past year or so. The government deficit will exceed 12% of GDP this year, and the total stock of government debt is expected to reach 113% of GDP, rising to 135% by 2011. And that is despite the Greek economy not suffering a deep recession, nor needing to provide large support to its banking sector. It is clear that, at the moment, the public finances are on an unsustainable path.
But that, in itself, does not automatically imply that the end game is a default. Even in a position as dire as the Greek government now finds itself in, the situation can still be rectified, provided the authorities have the political will. And the ECB and many other euro area members will not be displeased that the past week’s events have upped the pressure on the Greek government to get its fiscal house in order. We are now awaiting Greek Prime Minister Papandreou’s announcement on Monday, which is likely to set out sweeping cuts to Greece’s public administration. At the moment, we still think that Greece has the ability to sort out its fiscal problems on its own.
However, if the Greek government did run into funding difficulties, even that does not imply default. In our view, it is inconceivable that other euro area member states and, if necessary, international organisations would not step in. Reports from the EU leaders’ meeting in Brussels have indicated that Europe is keen to manage the crisis on its own, without IMF help, suggesting that contingency plans are being put in place.
Furthermore, the idea that the euro area is on the brink of losing Greece and possibly other members is simply absurd. If things are bad for the Greek public finances now, they would be many times worse if the government had to re-introduce (a version of) the Drachma. Investor appetite for Greek government debt would be almost non-existent. For a small country like Greece, one of the key attractions of joining the single currency in the first place was to eliminate currency crises. So, although the Greek government undoubtedly faces a significant challenge in getting its finances under control, talk of the break-up of the euro is just wishful thinking by (mainly) British eurosceptic commentators.
Colin Ellis, European Economist
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