Wait and see over long term prospects for Greece’s rescue deal

Success of the financial rescue package for Greece in the long term will depend on factors outside its control – and its capacity to implement the plan.

The package agreed at a European Union summit on Thursday includes €109bn in financing from the eurozone and the International Monetary Fund and an additional €50bn from financial institutions which will “voluntarily” agree to cut interest rates and lengthen maturities on Greek debt.

The EU leaders agreed to ease terms on bailout loans to Greece, Ireland and Portugal with maturities to be extended to 15 years from 7.5 years currently and interest cut to around 3.5%.

Initial reactions to the deal were broadly positive but economists and analysts were still waiting for more details to emerge about the plan.

The initial relief that a deal had been achieved gave way to some caution after rating agency Fitch announced that it would place Greece in temporary “restricted default” should plans to roll over debt or implement debt swaps go ahead.

“The reduction in interest rates and extension of maturities potentially offers Greece a window of opportunity to regain solvency, despite the formidable challenges that it faces,” said David Riley, head of sovereign ratings at Fitch.

The agency welcomed the agreement as “an important and positive step towards securing financial stability in the euro zone.” It provides a more unified and coherent policy response to the crisis and would ease pressure across the region, but it warned long-term success would depend on a sustained and broad-based economic recovery across the EU and making more progress on reducing government budget deficits, along with implementing structural reforms to boost growth. “Further episodes of financial market volatility cannot be discounted and downward pressure on sovereign ratings will persist,” it warned.

Part of the plan includes giving the European Financial Stability Facility (EFSF) greater operational flexibility, combined with the previous commitment to increase its net lending capacity to €440bn. This is expected to enhance its effectiveness in supporting financial stability in the euro zone.

The EU leaders also agreed to allow the EFSF to buy bonds in the secondary market to fight the crisis provided this is approved by the ECB. The EFSF will also be able to provide credit lines to member states before they are shut out of credit markets, and lend governments money to recapitalise banks, moves which Germany had previously blocked. The agreement also includes detailed provisions for limiting the damage that could be caused by a temporary default.

Greek Finance Minister Evangelos Venizelos welcomed the plan saying it brought needed relief which would gradually feed into the real economy. He admitted that the country would still have to make considerable efforts to overcome the crisis which has led to violent protests in Athens.

The Greek press largely welcomed the agreement but newspapers warned that hard work was needed to get public support to implement unpopular reforms including privatisations and steep public spending cuts. Some local newspapers warned that Greece could face decades of hardship as it struggles to repay its huge debt.

There are still doubts whether the plan goes far enough to resolve the eurozone’s worse ever crisis. French President Nicolas Sarkozy said the measures would reduce Greece’s debt by 24 percentage points of gross domestic product from about 150% today.

Analysts say that this would still leave Athens with an unsustainable debt load that could lead to bigger haircuts for bondholders in future. The stronger powers given to the EFSF may also be insufficient without much more funding should the crisis spread to other countries.

Some bond fund managers were more sceptical. The new framework may appease market fears for now, but more robust growth will be needed to calm the financial markets.

One euro bonds portfolio manager noted that while yields on 10 year Italian government bonds had fallen to 5.25% from 6% at the start of the week, showing that markets were reacting positively to the news of the agreement, concerns remained on Greece’s solvency as the potential write-down of debt may not be large enough. But such write-downs may be less difficult to achieve in future, he noted.

Another manager said clarification was needed on private sector involvement in the bailout plan and whether this referred to banks only and what happens to non-bank companies holding short dated Greek debt. The rescue package yielded more than expected but not enough to sleep comfortably, he said.


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