Bond Market Anticipates Greece Defaulting as EU Leaders Meet: Euro Credit

By Lukanyo Mnyanda and Marcus Bensasson
Mar 11, 2011 3:05 AM PT
BLOOMBERG

As European Union leaders haggle over their second plan to stem the financial crisis, traders are betting Greece won’t be able to pay its debts.

Greek 10-year bond yields rose to a record this week and it costs more than ever to insure against a default, even though the nation received a 110 billion-euro ($153 billion) bailout from the EU and the International Monetary Fund last year. Two- year yields exceed 10-year levels, suggesting a restructuring may come before the three-year aid program expires.

“The onus is on EU officials to dissuade the market from the notion that a debt restructuring is inevitable,” said Robin Marshall, director of fixed-income at London-based Smith & Williamson Investment Management, which oversees $20 billion. “They’ve lost investor confidence in any resolution that doesn’t involve some form of restructuring.”

EU leaders gather today in Brussels, aiming to agree to a blueprint to improve competitiveness, a plan Germany demanded as a condition for expanding the bailout effort. Investors will also be looking for signs that differences over how to solve the debt crisis are narrowing ahead of a second meeting on March 24- 25 that German Chancellor Angela Merkel has said will produce a comprehensive package of measures.

Greek securities plunged this week after Moody’s Investors Service cut the nation’s rating, already at junk, by an additional three levels, saying the probability of default had increased due to “implementation risks” in the budget cuts it is making as a condition of receiving aid.

Default Swaps

A restructuring of Greek debt is “a possibility” and investors may recover between 30 percent and 50 percent of the total value if that happens, said Moritz Kraemer, managing director of European sovereign ratings at Standard & Poor’s, on March 8. Credit-default swaps imply a 58 percent probability the nation will default within five years, according to CMA.

Yields on the bonds of the euro region’s most indebted nations have jumped in the last two months as Germany, Finland and Austria rebuffed calls from Greece and Ireland to lower the interest rates on rescue loans. Disagreements also persist over the remit of the 440 billion-euro European Financial Stability Facility, which provided loans to Ireland, including whether it should be allowed to buy euro-region government bonds.

Leaders will today debate a proposed pact that Merkel and her French counterpart Nicolas Sarkozy want as part of any reinforced plan to support cash-strapped nations. The bloc’s economically weaker countries have criticized the plan as an attack on their sovereignty.

‘More Flexibility’

Enda Kenny, Ireland’s new prime minister, asked conservative officials from the EU on March 4 that the cost of the nation’s bailout be cut. Spain’s Finance Minister Elena Salgado said on March 3 she backs “more flexibility” on Greece’s loans. Austrian Chancellor Werner Faymann said five days later that he’s “against changing the existing agreements.”

Merkel told German lawmakers in a closed-door briefing yesterday she would back lower interest rates for emergency loans if Greece agrees to sell state assets and Ireland backs a common corporate tax base in the euro region, said four legislators who attended the session of the European Affairs Committee in Berlin.

Portuguese 10-year bond yields reached 7.70 percent on March 9, the highest since at least 1997, when Bloomberg began collecting the data. On the same day, equivalent-maturity Italian yields climbed above 5 percent for the first time since November 2008, while Irish 10-year yields touched the most since February 1993.

Spending Cuts

“It doesn’t seem like a solution or compromise is around the corner,” said Orlando Green, assistant director of capital markets strategy at Credit Agricole SA in London. “We could see more spread widening if they are slow in coming up with a plan. It’s not all priced in yet.”

Swaps insuring Greek government bonds rose five basis points to an all-time high of 1,037 basis points yesterday, meaning that it costs $1.04 million annually to insure $10 million of debt for five years. The spread between Greek two-and 10-year securities was at 427 basis points today, the most since May, when the creation of the EFSF convinced markets that EU government wouldn’t let the euro fail.

Greece cut spending and raised taxes last year to bring down the budget deficit to 9.4 percent of gross domestic product from 15.4 percent in 2009. The government is due to announce steps for 2012 to 2014 this month as it seeks to bring the shortfall below the EU’s 3 percent limit. Its ability to boost revenue is constrained by an economy entering a third year of recession. GDP may shrink 3 percent this year, according to the EU and the IMF, after falling 4.5 percent in 2010.

‘Incomprehensible’

Such measures may not be enough to keep Greece solvent, according to Ben May, an economist at Capital Economics Ltd. in London, who estimates that the economy will contract by 4.5 percent this year, and 2 percent next year, causing public debt to spiral to 170 percent of GDP and making debt restructuring is “virtually inevitable.”

Downgrading Greek debt weeks before the EU decides on new measures for tackling the crisis was “incomprehensible” and “completely unjustifiable,” the nation’s finance ministry said on March 7. “It wouldn’t just be a problem for Greece, but for the whole euro zone,” if the bailout terms are not softened, Prime Minister George Papandreou said, according to an interview published in Le Monde newspaper yesterday.

About 20 percent of B1-rated sovereigns, non-financial companies and financial institutions default within a five-year period, Moody’s said on March 7.

“Markets are becoming more fearful of a Greek government default and are now expecting it to happen more quickly than a few months ago,” May said. “Greece is as far away as ever from convincing investors that it can get its public finances on a stable footing.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Marcus Bensasson in Athens at mbensasson@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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