IMF and ECB should share pain of Greek haircut, says Schroders

Europe’s cental bank and even the IMF should share in the haircuts on Greek debt that seem increasingly inevitable for private bondholders, but they may ultimately need recapitalising as a result, says UK asset manager Schroders.

Greece would need to impose a haircut “of at least 50% on its debt, to get itself back to a sustainable position”, said Schroders’ chief economist and strategist Keith Wade (pictured) and European economist Azad Zangana.

Its economy is stumbling in its third year of recession, and its finance minister admitted yesterday a deficit this year of 8.5% of GDP, missing the 7.6% target Athens agreed with its international lenders.

A broad-based trim would reduce Greece’s debt to GDP ratio to 80%, “a similar level to that held in core Europe”, but implying losses of €175bn on bondholders, in Schroders’ view.

However, so far haircuts have mainly been mentioned only in regards to private, not supra-sovereign, lenders.

Such limited cuts would only reduce Greece’s ratio to 20%.

In Schroders’ view that is “clearly not enough. For the strategy to be effective, official lenders cannot be excluded from future hair-cuts, which effectively amount to fiscal transfers. This may require the ECB and IMF to be recapitalised at some stage.”

European Banking Authority summer stress tests showed non-Greek banks hold only about €32bn, about half the amount held at the ECB.

Bi-lateral soveriegn lenders including the IMF hold a further €20bn to €60bn.

The IMF and European Union are withholding mid-October’s next tranche of aid until Athens acts more decisively, but Schroders said its property tax that aimed to do this was “only kicking the can down the road”.

“Perhaps the most important development of the past month is the recognition by the EU, IMF and ECB that Greece is broke and will not repay its debts.”

The $328.7bn asset manager then described three steps for an orderly default, but said it was unlikely they would be taken before this month’s G20 meeting.

The asset manager said “recognising the need to restructure Greek debt” was Step One for the troika, even if some banks would need recapitalising as a result.

Step Two: boosting the bail-out fund from its current €440bn. Eurozone governments are already voting on this, but Schroders warned “clearly there is a balance to be struck between increasing the scale of the fund, and not undermining the credit ratings of contributors”.

The final step would be growth stimuli in the currency bloc.

“This might come from Germany in the form of a public spending boost, but given that fiscal policy is currently moving in the opposite direction, the burden will no doubt fall once again on the ECB. Liquidity provision could be stepped up and we may even see a rate cut.

“Should these three steps be carried out with speed and conviction there is a chance of an orderly default by Greece with collateral damage to the banks and contagion to the periphery being contained.

“Unfortunately, ‘speed’ and ‘conviction’ are not words closely associated with the euro area. Greece may well get the next trance of its bailout, but the lack of a more permanent solution is likely to weigh on markets into 2012.”

A final measure – more of a ‘leap’ than a ‘step’ – would be fiscal union in the zone, Schroders said.

“The current account is close to balance implying that savings equal investment across the area. The problem is that this is made up of surpluses in the core and deficits in the periphery. There is no mechanism to recycle funds from one to the other.

“This will ultimately need to be replaced by a more formal fiscal union and probably the creation of a common eurobond that members can issue up to a percentage of their GDP. This would seem to be the only means that the Euro can remain intact in the medium term.

“We are set to see plenty more crises before we arrive at the destination. Our view is that the euro can muster the will to achieve this, but it will be a close call as to whether it will join the long list of failed currency unions.”

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