Greece: Financing risks

15 January 2010
Focus Europe
Greece: Financing risks
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Persistent twin deficits over a multi year period
have left Greece heavily indebted from both a
public and external perspective. More than ample
global liquidity combined with access to ECB
liquidity facilities has meant that financing of
these deficits has not been problematic in the
past but now leaves Greece at risk of a potentially
sharp withdrawal of capital at some point in the
future.
In 2010 Greece is likely to under-perform its peers
on growth.
Fiscal consolidation, a poor
competitiveness position and crowding out risks
mean that the government’s assumption for GDP
contraction of 0.3% could prove optimistic.
Financing pressures are emerging. This week the
government focused on t-bill issuance but large
redemptions in April and May mean that this
strategy is unlikely to be successful over a multimonth period. Should the government choose to
rely on the domestic banking sector for a large
chunk of its financing, it risks forcing a sharp
decline in private sector credit and a much
sharper contraction in GDP.
PM
Papandreou
and
Finance
Minister
Papaconstantinou have put forward a reform
programme to the European Commission. This
represents the first in what must be a very long
series of steps forward for Greece as it puts public
and external debt on a more sustainable path. Its
failure to stabilize bond yields is of real concern
however as it limits government efforts to
improve its liquidity position and increases the
risk that the sovereign is forced towards funding
from the official sector.
Greece: A persistent twin deficits country
Greece’s twin deficits rival those of all other EMU
countries. Over 2000-08 Greece’s C/A deficit averaged
9.0% of GDP, narrower only to Portugal (-9.2% of GDP).
Its budget deficit, at an average of 5.1% of GDP, was the
widest in the Euro Area. For 2009 Greece is expected to
post a budget deficit of 12.7% of GDP. The end result is
that Greece has been left heavily indebted from both a
public and external perspective. Public debt at 97% of
GDP at end-08 was the second highest in the Euro Area
and 29.9pp above the EMU average. The European
Commission projects an increase to 124.9% of GDP by
the end of this year, making it the most indebted
economy within EMU. This compares unfavourably with
an end-2010 projection for EMU as a whole of 88.2%.
Deutsche Bank AG/London
Greece has run persistent twin deficits (2000-08 average)
6
4
Budget (%
of GDP)
F inland
Lux
2
Ireland
B elgium
Spain
0
A us
C yprus
-2
Slo v enia
F ranc e
P o rtugal
-4
G re e c e
-6
-15
-10
N etherlands
Germ any
Italy
M alta
-5
C/A (%of GDP)
0
5
10
15
Source: DB Global Markets Research, European Commission, National central banks
Drawing off a country’s net international investment
position as a measure of external indebtedness, Greece
outperforms only Spain and Portugal. At end-08 the
economy’s external liabilities exceeded its external assets
by 74.9% of its GDP. The Euro area as a whole registered
a negative net international investment position of 17.7%
of GDP.
EMU public debt (2008)
120
% of GDP
100
ITA
GRE
BEL
FRA
AUS GER
EMU
NET MAL POR
60
CYP
IRE
SPA
FIN
40
SLK
SLN
20 LUX
80
0
Source: DB Global Markets Research, European Commission
Page 9
15 January 2010
Focus Europe
A snapshot of net international investment positions
(2008)
80
40
0
-40
20
% of GDP
LUX
FIN
% of GDP
0
GER
BEL
CYP NET
MAL
-20
-40
-60
EMU
AUS FRAITASLN
-80
-120
SLV
IRE
GRE
SPA
POR
Source: DB Global Markets Research, national central banks
Greece is not the only fiscal offender…
In terms of fiscal performance over recent years, there is
little doubt but that it was pro-cyclical in nature. Between
2000 and 2008 the public sector wage bill rose by 92.3%
in Greece. There are other offenders within the Euro Area
also. In Ireland and Spain the public sector wage bill rose
by 141.4% and 81.8% respectively. But Greece’s poor
track record on fiscal performance and its higher public
debt ratio puts it at more of a disadvantage. Since 1990
Greece’s fiscal deficit has only fallen within the Stability
and Growth Pact 3% of GDP limit in one year – 2006, and
even this is likely to be revised wider once various arrears
announced by the new government are accounted for.
Since 1990 Ireland’s budget balance was consistently
within the 3% limit until 2008. Spain’s deficit fell within
the limit consistently between 1999 and 2007. Since EU
accession the government has now twice had to
announce upward revisions to already published budget
deficit data as various items of expenditure were not
declared punctually.
… but its external borrowing is an added concern
It is unlikely that Greece would have been able to run such
wide twin deficits over recent years were it not for easy
access to ample liquidity at low interest rates, for most of
the period from global capital markets and from mid 2008
onwards also from the ECB. Such inflows leave an
economy vulnerable to a sharp withdrawal of funds at
some point in the future should foreigners lose
confidence or face liquidity constraints that prevent them
from maintaining this exposure. A breakdown of net
international investment positions for some of the more
vulnerable EMU economies highlights this predicament.
Page 10
Net international investment positions: A breakdown
-80
Other
Loans
Portfolio
Direct invest
-100
-120
Greece
Ireland
Portugal
Spain
Source: DB Global Markets Research, national central banks
Portfolio liabilities in Greece: A breakdown
120
Equity
Private debt
100
Public debt
Money markets
% of GDP
80
60
40
20
0
-20
2004
2005
2006
2007
2008
Source: DB Global Markets Research, Bank of Greece
Financing of C/A deficits generally takes two forms – debt
creating and non-debt creating inflows. Non-debt related
inflows refer to FDI and equity, debt-related inflows can
be in the form of either portfolio flows into domestic
public or private fixed income markets or loans (e.g. trade
credit, syndicated loans). In Greece’s case the majority of
its negative net international investment position relates to
portfolio flows into the public sector which foreigners can
choose to sell whenever they wish. At end-Q3 foreigners
held EUR216bn of Greek government debt (72.3% of the
total market, 90.2% of GDP), having doubled their position
since end-04. Given recent downgrades and another
round of revisions to budget data from previous years, a
sharp slowdown or even reversal of inflows from
foreigners into the local debt market has become an
increasing risk. In the case of Portugal, Spain and Ireland
its international investment position is also largely driven
by debt-creating flows but these are in the form of loans
rather than portfolio inflows, suggesting that any
withdrawal of capital should be more staggered but
nonetheless possible.
Deutsche Bank AG/London
15 January 2010
Focus Europe
Foreign bank holdings of European government debt
30
25
20
Q2-09 fo reign
claims o n
public secto r
(% o f
bo rro wer
GDP )
Greece
P o rtugal
15
B elgium
A ustria
Ireland
Germany
Netherl.
Finland Cyprus
France
Slo vakia
Spain
Slo venia
UK
Denmar
Sweden M alta
10
5
0
30
50
70
Italy
2009 public debt to GDP
90
110
130
Source: DB Global Markets Research, European Commission, BIS
Since Q3 last year Greece has also been able to take
advantage of the ECB’s extended liquidity facilities. Even
if a member of a common currency area such as EMU, a
country may not have access to sufficient funds. Via its
extended liquidity facilities the ECB largely removed this
risk for the past 18 months.
Greece has shown
willingness to draw off such funds. At end-October
borrowing by domestic Greek banks from the ECB via the
Greek central bank stood at 8.9% of Greek banking sector
assets.
ECB tenders: Drawdown as % of domestic banking
sector assets
10.0%
9.0%
8.0%
7.0%
Jul-08
6.0%
Oct-09
5.0%
4.0%
3.0%
that GDP in absolute terms remains unchanged between
Q4-09 and Q4-10, GDP for the entirety of 2010 in Greece
will decline by 0.2pp. In Ireland the same exercise shows
GDP unchanged while the Euro Area enjoys positive
carryover of 0.2%.
More fundamentally the economy will have to weather
contractionary fiscal policy and the impact of a poor
competitiveness position. From a deficit of 12.7% of
GDP this year, the government pledges a reduction of up
to 4% next year. Its poor competitiveness position is also
likely to drag on economic activity. The IMF’s Article IV
review from August of last year points to nominal unit
labour cost growth in excess of EMU, a decline in relative
export prices since 2000 of 20%, compared with less than
5% in France and Germany, a decline in export market
share of in excess of 25% and poor global
competitiveness rankings. Given that it is the least open
economy in Euroland (exports and imports of goods and
services total 45.4% of GDP), it also stands to gain least
from any continuation in the recovery in global growth.
Severe crowding out risks
Probably the most urgent risk emanates from uncertainty
on sources of government financing and potential related
crowding out issues. While Greece’s fiscal deficits have
been wide for some time now, as discussed above,
foreigners have been happy to finance these deficits in full
and more. Over 2004-08 portfolio inflows from abroad
into the domestic debt market, for the most part
government debt market, averaged 11.2% of GDP. Over
2005-09 we estimate that foreigners (a combination of
banks, insurance/mutual/pension funds, hedge funds and
central banks/sovereign wealth funds) on average
financed 155% of Greece’s government deficit.
Foreigners have been happy to finance Greece’s deficit
in full and more
2.0%
1.0%
0.0%
NL
GE
IRL
IT
ESP P O
GR
AU
FI
FR
BE
Source: DB Global Markets Research, national central banks
Downside risks to growth
To date economic activity in Greece has held up much
better than most of its other EMU peers. GDP for the
Euro area economy as a whole began to contract in Q2-08
and has since fallen 4.8%. Ireland and Spain have seen a
decline of 9.3% and 4.5% over the same period. In
contrast the cumulative decline to date in Greece is a
much more muted 1%. Relative to most other EMU
economies however Greece is likely to struggle in 2010
and the government’s budget assumption of a contraction
in GDP of 0.3% could prove optimistic.
From a mechanical perspective, the potential for carryover
in terms of GDP gains is smaller in Greece. Assuming
Deutsche Bank AG/London
300
250
Foreign buying (%
of budget deficit)
200
150
100
50
0
2005
2006
2007
2008
2009
Source: DB Global Markets Research, Bank of Greece & Ministry of Finance
At EUR53bn, Greece’s gross financing requirement in
2010 is below 2009’s which was in excess of EUR60bn.
However global financing conditions in 2010 are unlikely
to be as favourable for sovereigns as last year. Central
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15 January 2010
Focus Europe
banks are beginning to reverse special liquidity facilities
while government bond issuance in the developed world
remains elevated. Our Euroland strategy team estimates
sovereign issuance this year at EUR1005bn (net at
EUR484bn), up from EUR907bn (net at EUR373bn) in
2009.
Greece’s 2010 financing requirement
14.0
12.0
90
8.0
80
Redemptions +
interest
6.0
% o f market held by fo reigners
220
% o f GDP
200
Go vt debt held by fo reigners (EURbn,rhs)
Deficit
10.0
Foreign holdings of Greek government debt
100
EURbn
4.0
2.0
0.0
180
70
160
60
140
50
120
40
100
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: DB Global Markets Research, Greek Ministry of Finance
2004
2005
2006
2007
2008
2009
Source: DB Global Markets Research, Bank of Greece & Ministry of Finance
The Greek authorities indicated in December that they had
not undertaken any pre-financing for 2010 while fiscal
developments over recent months combined with
sovereign downgrades have prompted markets to price in
more risk premium. S&P and Fitch currently rate Greece
at BBB+, S&P with a credit watch negative, Fitch with a
negative outlook. Moody’s rates Greece A2 with a
negative outlook. These downgrades have already been
sufficient to prompt the exit of Greek inflation linkers from
a leading index – relevant for EUR13bn of Greek
government bonds.
Given the risks of another
downgrade, investors may turn increasingly concerned
about the impact of a normalisation of ECB collateral
requirements currently scheduled for next January.
Currently collateral requires only one investment grade
rating from any of the three rating agencies. If all
proceeds as scheduled this will return to one single A
rating next January. On Thursday ECB President Trichet
indicated that the ECB will not change the collateral
framework for any country.
Ideally the authorities no doubt hope that financing from
foreign private sector counterparts will remain available
throughout this year. But signs of strain are already
emerging in Greece. The debt management agency has
announced that it will not sell any bonds to the market this
month but will instead focus on t-bill issuance. While bid
to cover ratios on this week’s EUR2.1bn of 26 week and
52 week bonds remained comfortable, yields on the 52
week bills rose a significant 119bp to 2.2%. This is very
likely to be successful for now but unsustainable over a
multi-month horizon. The government’s gross financing
requirement rises to EUR25.2bn over April-May.
Full financing from the domestic banking sector is
probably also not viable. December saw the government
sell EUR2bn in bonds in the form of a private placement
to 5 banks, 4 of which were Greek.
Should the
government rely entirely on its domestic banking sector
for financing this year, it would result in a 163% increase
in their holdings of Greek government debt relative to endOctober (EUR32.5bn)1. In the absence of an increase in
banking sector liabilities, Greek banks would move from
holding 8% of their assets in Greek government debt at
end October to 20.2% of their total assets by end-2010.
This would only materialise if Greek government debt
could not be posted at the ECB as collateral but would
undoubtedly translate into a sharp fall in the stock of
private sector credit and a more negative growth outcome
than is projected by the government, endangering the
government’s fiscal targets.
It is about debt as well as deficits
On Thursday the government presented an outline of its
Stability and Growth Programme targeting a fiscal deficit
within 3% of GDP in 2012. The package consists of a
series of revenue and expenditure measures (these
1
The Bank of Greece’s statistical bulletin shows only Greek bank holdings
of EMU government securities. We assume that this relates in full to
Greek government bonds but acknowledge that that may not be the case.
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Deutsche Bank AG/London
15 January 2010
Focus Europe
include a reduction in public sector employment, a 10%
cut in salary entitlements and freezing of nominal wages),
pledges legislation in Q1 to render the National Statistics
Service independent to improve data reliability, reforms to
strengthen the monitoring of budget legislation and
measures to tackle pensions and the healthcare system.
Upon announcement of the European Commission’s
assessment of Greece’s fiscal package on 15th February,
neither the Greek authorities nor the European
Commission is likely keen to worry markets further by
announcing a programme that will visibly not achieve the
government’s budget target.
Is this sufficient? We view it as a very important step
forward in what must be a multi-year period of reform to
set both public and external debt on a more sustainable
path. Should markets prove willing to give the authorities
Deutsche Bank AG/London
some time to prove their commitment to implementation,
financing pressures should ease in the near term, though
such elevated debt ratios leave no room for slippage and
financing risks will remain ever-present. Initial signals are
not encouraging however and this week’s continued
widening in Greek bond spreads (58bp in the 10yr over
Tuesday-Thursday alone) is of real concern.
In the
absence of a stabilisation in bond yields over the coming
weeks and successful issuance of a meaningful amount of
debt, the sovereign’s ability to access markets will be
further impaired and risks endangering sovereign liquidity
to an extent that could force the authorities towards
official funding.
Gillian Edgeworth, (44) 20 7547 4900
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