The situation in Greece
The situation in Greece has recently escalated because of the lack of transparency, spurious reporting of statistics and imminent refinancing needs.
But despite only recently hitting the headlines, the Greek crisis has been building for years.
In joining the EU and adopting the Euro currency in 2001, Greece gained unprecedented access to capital markets and government spending escalated.
The Global Financial Crisis has exposed the risks of escalating public and private debt. Economic slowdown, which drove falling government revenues and rising debt levels, came at the same time as markets tightened.
The Greek government called a snap election for October 2009, seeking a mandate to address the deteriorating financial position. In a demonstration of the difficulties in raising public support for reform, the government was soundly defeated. The new government quickly revealed that the position was worse than thought. Greece’s public debt was larger than the total size of the economy.
By late 2009, credit rating agencies begun to downgrade Greece’s sovereign credit rating. With large amounts of debt requiring refinancing over the coming months, the markets will soon be tested further.
Where are we now?
The situation has spooked already nervous capital markets. Following the brief scare over Dubai debt, some mixed signals on global economic recovery and concerns about corporate earnings growth, global sharemarkets fell by 6.4 per cent from mid January to mid February.
Until recently, it appeared that Greece’s budget deficit would be well within the EU target limit of 5 per cent of GDP. The latest estimate is 12.7 per cent of GDP. Greece is now in breach of a number of EU rules and the EU’s credibility has been dented.
Consequently, the Euro has weekend against the US Dollar by 9 per cent since peaking in November last year.
The immediate situation has now regained some stability. Greece successfully placed an €8 billion issue of bonds in early February, and the EU is negotiating support for the cluster of redemptions due in March and April.
There are many strings attached in accepting assistance from the EU. The Greek government has already abandoned many of its election spending promises and is imposing tough new taxes. The fix will not be pleasant for the people of Greece and civil unrest has already risen.
Is the risk of contagion real?
Sovereign debt defaults are not uncommon. Over the past 15 years we have seen defaults on government debt issued by countries such as Brazil, Argentina, Russia, Ukraine, Pakistan, Ecuador and Uruguay.
A key difference here is that Greece is an established, developed economy and a member of the EU.
Given that Greece only accounts for 2.6 per cent of euro area GDP and is less than 1 per cent of the global economy, the direct impact is not a major concern.
The credibility of the EU and the Euro is a bigger issue. Several other members have challenging financial positions and cannot afford a weakening of Euroland’s position in capital markets.
What does this mean for investment markets?
It’s unlikely that Greece will default on its debt obligations or leave the EU in the near term.
Greece is not an isolated case. The spook to the markets has demonstrated the need for governments to get on top of their debt levels and sort out credible exit strategies.
This is likely to lead to slower levels of future economic growth for the Eurozone area.
Not all government guaranteed bonds are the same. The large issuance of government bonds across the globe is creating opportunities and risks.
For example, by December 2009 the yield on 10-year Greek Government bonds peaked at 7.1 per cent. This yield was approximately 4 per cent higher than 10-year US Treasury yields. In previous months this difference had been as low as 1 per cent.
Investors can expect ongoing episodes of market disruption for a long time. The central case is that they will be resolved, but markets may react quite negatively in the short term.
