Greece: The first domino?
Greece stole the limelight early on this year with its bid to renegotiate its bailout funding, but the real story may lie elsewhere in Europe.
Alexis Tsipras, leader of Greece’s leftwing, anti-austerity party Syriza, won the country’s general elections at the end of January. He has made clear since day one that his main objective is renegotiating Greece’s debt with the Troika.
At the time of writing, talks were being held between the two parties and no significant deal seemed to be in sight. Quite the opposite: the Greeks were determined to snatch a restructuring of the debt while the Troika kept repeating that the Greeks have to abide by the deal. While it did not have a disruptive effect on global markets per se, the Greek elections seem to be the first of a series of general elections that are perceived by the selector community to be likely to spark prolonged volatility going forward.
Early in May, the UK will hold its own general elections. Looming as a particular risk is the nationalist party Ukip (UK Independence Party), which has made an in/out referendum on EU membership its strong suit. Polls suggest that the country will again face a hung parliament, given the way parliamentary seats in the UK can be won with far less than 50% of the vote in any individual constituency, which would force a coalition to govern.
Besides Ukip, the Conservative party, which is one of two in the current ruling coalition, has also said it would commit to an in/out referendum on UK membership of the EU by 2017, albeit following a period of trying to renegotiate certain points of the existing membership.
Elsewhere, Spain is looking to hold elections towards the end of the year – currently the end of November seems to be the most likely time – and left-wing, anti-austerity party Podemos is scoring high in the polls on an agenda of debt cancellation and public control of the banks and energy companies.
Why is this important?
Put simply, the relative importance of the sovereign bond markets for UK and Spanish debt mean that they are far more likely to be of direct consequence to investors. Greece may owe its creditors some €240bn, but the estimated size of the UK gilt market is over €1.8trn, of which €562bn is estimated to be held outside the country, according to UK Debt Management Office data.
As of early-mid February, yields on 10 year UK and Spanish government bonds versus German Bunds were clearly not anywhere near those for Greek debt (see chart, above right) but neither were they among the narrowest as measured by a spread versus German government debt – suggesting the market sees some ongoing risks.
Indeed, the yield data seems to suggest that the UK is considered in the same light as others on the EU periphery – perhaps reflecting concerns over continued deficit spending and rising national debt despite several years of austerity measures.
Portugal too faces elections later this year, and its yields are also relatively high, some 200bps over Bunds according to this particular snapshot. And, as the case of Greece has indicated, despite the best expectations of markets, these elections could unleash significant uncertainty on markets.
Consider, for example, that a so called Standard Note published in the UK House of Commons Library in October 2014 showed a dispersion in the estimated cost/benefit to UK GDP of the country’s membership of the EU as between -5% (Ukip estimate) through to +6% (the UK’s Department for Business Innovation and Skills (a ministry currently headed by a member of one of the more pro-EU parties in the UK, the Liberal Democrats). That said, Ukip polled 27.49% against 6.87% for the Liberal Democrats in the May 2014 European Parliamentary elections.
There is no estimate of what a UK exit from the EU altogether would bring. The House of Commons data suggests total imports and exports between the UK and other EU27 has declined slightly in 2002-2012, but UK goods exports to the Union in 2013 were still some £155bn.
However, it is not just in the UK that the cost/benefit analysis debate is taking place. In Germany, the Ifo Institute estimates that a Greek default combined with an exit from the eurozone would cost the German state up to €76bn, a Greek default without exit from the eurozone would cost the German state €77.1bn. Yet the estimate does not factor in the sharp decline of German borrowing costs as a result of the crisis in the eurozone.
According to Klaus Regling, head of the ESM permanent bail out fund, Germany is saving between €10 and €20bn a year due to the reduction in borrowing costs.