UBS Counts The Nails In Greece's Coffin
UBS' economics research group do not believe that Greece is saved but hope that it is at best ring-fenced. In an excellent Q&A follow up, Stephane Deo and his team address the role of the EFSF, the IMF package and its austerity measures, the ECB's participation, and finally the likelihood of the PSI being successful and its fallout. As Greek 2Y yields break 200% (obviously price is the critical part but these yields are stupendous) and bridge loan discussions appear for the March 20th maturity, perhaps UBS view of the IMF 'walking away' is more credible if they manage to ring-fence a recap of the banking sector. We would be surprised if contagion was contained and, as we have seen before, that risk leaks out somewhere and unintended consequences (or unknown unknowns) tend to pop up just when we least expect them. Perhaps the FT's note this morning that deadlines are slipping rapidly is the bright yellow canary in the Piraeus coal-mine as'time is running out' for a solution here very quickly (as seemingly is the desire).
UBS: Q&A on Greece
UBS published on January 20 a piece called “Q&A on the Greek debt restructuring”. Given the news flow recently, we thought it was time to update.
What will be EFSF role?
In short the EFSF will provide a total of 93.7Bn which will be used for 30Bn as a part of the PSI, 35Bn to buy the ECB portfolio at cost, 5.7Bn to pay arrears on coupon payments and 23Bn to recapitalise the banking sector.
A draft of the EFSF and Greece agreement has been made available over the weekend. The relevant part of the agreement is the following:
Upon the request of financial assistance from Greece and in line with PSI MoU, EFSF has entered or will enter into Financial Assistance Facility Agreements with Greece and the Bank of Greece, to provide the following Financial Assistance Facilities:
(i) on 2012, a financial assistance facility agreement of up to €[30,000,000,000] in order to permit Greece to finance, in part, the Voluntary Liability Management Transaction (the "PSI LM Facility");
(ii) on 2012, a financial assistance facility agreement of € 35,000,000,000 in order to permit Greece to finance the Buy-Back Offer (the "ECB Credit Enhancement Facility");
(iii) on 2012, a financial assistance facility agreement of € [5,700,000,000] in order to facilitate the making of payments in relation to accrued interest under certain outstanding sovereign bonds issued by Greece, in the context of the Voluntary Liability Management Transaction, such payments to be made at the time and to the extent that such sovereign bonds are exchanged for New Greek Bonds (the "Bond Interest Facility"); and
(iv) on 2012, a financial assistance facility agreement of € [23,000,000,000] in order to finance the recapitalisation of certain financial institutions in Greece (the "Bank Recapitalisation Facility").
The issue then, we believe, is how the EFSF obtains its funding. It seems very difficult to us to imagine that the EFSF can indeed issue 93.7Bn, if these numbers are confirmed, especially because a number of the above lines will have to be issued in the near future, when the PSI is enacted. However, the same agreement reads:
EFSF shall finance the making of such Financial Assistance by issuing or entering into bonds, notes, commercial paper, debt securities or other financing arrangements
Rather we believe that part will be done without issuance in the market. In the case of the PSI the agreement could be that the investors directly receive EFSF paper instead of cash from the EFSF. In the case of the ECB the procedure could be a form of swap between the Eurosystem’s portfolio and EFSF paper.
What austerity package?
The additional adjustment program voted by the Parliament this week end includes a number of new measures. The plan was published yesterday and it is articulated in 4 macro-areas:
1) Fiscal consolidation
- Migration to a stable primary balance at 4% of GDP by 2014
2) Fiscal structural reforms
- EUR50 bln privatization plan
- Taxation system reform: legal simplification and harsher and more efficient fight against tax evasion
- 150K reduction in public sector payroll by 2015 (15K in 2012)
- Pension and health care system reforms: long-term sustainability and modernization
3) Financial sector regulation and supervision
- Capital adequacy requirements: 9% Core Tier-I ratio by 2012Q2 (10% by 2013Q2), 7% in 2014 under a stressed scenario
- Recapitalization plan implemented y the Hellenic Financial Stability Fund
- Legislation overhaul for HFSF, HDIGF (Hellenic Deposit and Insurance Guarantee Fund), Bank of Greece and bank resolution mechanisms
4) Growth-enhancing measures
- Reduction of legal minimum wage by 22% (35% for young workers)
- Wage setting system reform (more flexibility in collective agreements)
- Fight to undeclared work and social contribution evasion
- Liberalization of a number of closed professions and service sectors (retail, employment agencies...), elimination of minimum fees charged by professionals, other competition-enhancing interventions
- Upgrade and reform of the education and judiciary systems
In total the supplementary measures on the spending side amount to €3.2Bn (1.5% of GDP). In addition, Greece will need to propose by June additional measures on the expense side for EUR11Bn spanning on the period 2013-2015.
Greek unit labour costs have risen in 2004-2011 26%, almost twice the Euroarea average (+14%). The Greek minimum wage is twice as high as in Portugal and six times higher than in neighbouring Bulgaria, where indeed many Greek companies relocated in recent times. Unsurprisingly, export shares and the current account have continued to deteriorate in the same period. A correction is certainly needed. Whether this will be reached via lowering minimum wages is unclear, considering that many Greek workers are already employed off the books and paid wages well below the legal minimum. Also, the lay-off of 150K public workers could add up to 4% to the unemployment rate. So, while these measures may produce competitiveness gains in the long run, will most likely exacerbate the drop in aggregate demand in the short run, putting ever more weight on an already moribund economy (Greek GDP declined 15% in real terms since 2007).
Voluntary PSI or not (and CDS triggered or not)?
We think it will be non-voluntary, with CAC, hence CDS triggered
We keep our view that the “voluntary” exchange is unlikely to lead to a participation rate that is high enough to convince the IMF. This means that a coercive option has to be chosen, hence the CAC voted by the Parliament. If CAC are imposed, the CDS will be triggered.
Will the ECB participate?
Yes, but not directly on PSI, just at cost.
On our numbers, the ECB had spent close to 40Bn to purchase Greek bonds (38.5Bn to be precise). It is obviously possible that our number are inaccurate, the exact figure has not been made available. However, if the actual figure is indeed above 35Bn as we think, it means that the ECB is not only transferring its portfolio at cost but also probably giving back the interest earned on the portfolio.
Again on our numbers, this would be a c1/3 haircut on the ECB portfolio nominal value. This means that it would not remove totally the seniority argument on the ECB portfolio, as the haircut supported by the ECB is considerably smaller than that of private investors. In our last piece we wrote “on balance we think the ECB will receive a haircut”, we were only half right: they did receive a haircut, but quite a smaller one than the market.
How will the bailout plan 2 work?
Out of the EUR110Bn earmarked for the first bailout plan, only 74Bn (the first 6 tranches) have been already disbursed. The rest will not be paid because the first plan has been discontinued and will be substituted by the new plan. This will be managed in the same way as the first, with quarterly payments conditional on a positive IMF/EU/ECB review.
What is the timing going forward?
15 FEB – EU finance ministers were supposed to meet in Brussels to sign off the second bailout plan. This has been postponed but a teleconference is still apparently planned. So a conditional approval could be issued in order for the PSI to be launched.
17 FEB – Last available date for setting the PSI according to MoF Venizelos.
20 FEB – The meeting of EU ministers due on Feb-15 has been postponed to Feb-20, this meeting will finally sign off the second bailout plan, conditional on Greek party leaders having signed a document committing to implement the plan whoever wins the elections scheduled in April.
20 MAR – EUR14.5Bn of Greek paper comes to maturity. Without the new bailout plan the Greek state will mostly be unable to repay. Note that there is a 7-day grace period, which can be followed by bank holidays. So the deadline could be extended a bit more than a week after March-20.
1 APR – Elections schedule. Date to be confirmed.
Is Greece saved?
No, but we could hope it is ring fenced.
We think the second bailout and PSI will not provide a lasting solution for Greece. This is for two reasons:
1) The bailout plan sets a very ambitious target, partly based on growth assumption we see as optimistic (see charts below). To stick to the plan, Greece would have to almost halve its deficit to 4.7% from 9% in 2012. We calculate the PSI to reduce interest payment by 1.7% of GDP this year, leaving an additional 2.6% correction needed. In 2014 Greece should again reduce its deficit from 3.9 to 1.4%. All this should happen amidst the worst recession since wartime, a fractured political system and rising social tensions. On top of this, the IMF assumes growth to come back to Greece as soon as in the next year. With no signs of adjustment, fleeing investments and further austerity, we see this as unlikely
2) Even assuming the plan will work out, Greece will find itself in 2020 with 120% debt/GDP and interest expenditures equal to 4% of GDP. Its debt sustainability in the long run will still be in doubt.
We do not see the PSI as saving Greece. As we repeatedly argued, the imbalances are too wide to be solved by any debt restructuring: budget deficit, external imbalances and international competitiveness to name a few. What this PSI might do (only “might”) is ring fence Greece. First because the private sector exposure will be cut by 70% via the PSI. Second because the recapitalisation of Greek banks will reduce the risk of the financial system imploding in Greece. Third, because after the PSI the issue becomes essentially an IMF “classical” programme: funding the deficit and rebalancing an economy.
So what’s next?
IMF playing very hard, possibly just walking away.
As expressed above the PSI does not solve the problem, but if we are right that it ring fences Greece, it means that the attitude of the IMF will change. The option envisaged by the IMF to just walk away, as they did with some countries in the past, was too dangerous before the recapitalisation of the banking sector. A Greek default with no recapitalisation of the banks would have left Greece with no option but to print its own money. When recapitalisation is done, the option for the IMF to just “walk away” becomes much more credible. We thus believe the IMF will be much more strict with Greece, will not tolerate slippage in deficit and we do believe that a premature termination of the Greek programme is a distinct possibility.
How this will be done? One idea that has been floated is to provide IMF funding via an escrow account that would first service the debt and then be used for the remaining part to fund the primary deficit. Greece would thus not get more than agreed during the plan.
The risk obviously is that, when Greece moves back to a primary surplus, the IMF/EC funding would be used only to fund interest payments. At this point Greece would have an incentive to cut debt service by reducing the coupon payments. We think there is a distinct possibility at this point to embark on a PSI-2 negotiation.
UBS' economics research group do not believe that Greece is saved but hope that it is at best ring-fenced. In an excellent Q&A follow up, Stephane Deo and his team address the role of the EFSF, the IMF package and its austerity measures, the ECB's participation, and finally the likelihood of the PSI being successful and its fallout. As Greek 2Y yields break 200% (obviously price is the critical part but these yields are stupendous) and bridge loan discussions appear for the March 20th maturity, perhaps UBS view of the IMF 'walking away' is more credible if they manage to ring-fence a recap of the banking sector. We would be surprised if contagion was contained and, as we have seen before, that risk leaks out somewhere and unintended consequences (or unknown unknowns) tend to pop up just when we least expect them. Perhaps the FT's note this morning that deadlines are slipping rapidly is the bright yellow canary in the Piraeus coal-mine as'time is running out' for a solution here very quickly (as seemingly is the desire).
UBS: Q&A on Greece
UBS published on January 20 a piece called “Q&A on the Greek debt restructuring”. Given the news flow recently, we thought it was time to update.
What will be EFSF role?
In short the EFSF will provide a total of 93.7Bn which will be used for 30Bn as a part of the PSI, 35Bn to buy the ECB portfolio at cost, 5.7Bn to pay arrears on coupon payments and 23Bn to recapitalise the banking sector.
A draft of the EFSF and Greece agreement has been made available over the weekend. The relevant part of the agreement is the following:
Upon the request of financial assistance from Greece and in line with PSI MoU, EFSF has entered or will enter into Financial Assistance Facility Agreements with Greece and the Bank of Greece, to provide the following Financial Assistance Facilities:
(i) on 2012, a financial assistance facility agreement of up to €[30,000,000,000] in order to permit Greece to finance, in part, the Voluntary Liability Management Transaction (the "PSI LM Facility");
(ii) on 2012, a financial assistance facility agreement of € 35,000,000,000 in order to permit Greece to finance the Buy-Back Offer (the "ECB Credit Enhancement Facility");
(iii) on 2012, a financial assistance facility agreement of € [5,700,000,000] in order to facilitate the making of payments in relation to accrued interest under certain outstanding sovereign bonds issued by Greece, in the context of the Voluntary Liability Management Transaction, such payments to be made at the time and to the extent that such sovereign bonds are exchanged for New Greek Bonds (the "Bond Interest Facility"); and
(iv) on 2012, a financial assistance facility agreement of € [23,000,000,000] in order to finance the recapitalisation of certain financial institutions in Greece (the "Bank Recapitalisation Facility").
The issue then, we believe, is how the EFSF obtains its funding. It seems very difficult to us to imagine that the EFSF can indeed issue 93.7Bn, if these numbers are confirmed, especially because a number of the above lines will have to be issued in the near future, when the PSI is enacted. However, the same agreement reads:
EFSF shall finance the making of such Financial Assistance by issuing or entering into bonds, notes, commercial paper, debt securities or other financing arrangements
Rather we believe that part will be done without issuance in the market. In the case of the PSI the agreement could be that the investors directly receive EFSF paper instead of cash from the EFSF. In the case of the ECB the procedure could be a form of swap between the Eurosystem’s portfolio and EFSF paper.
What austerity package?
The additional adjustment program voted by the Parliament this week end includes a number of new measures. The plan was published yesterday and it is articulated in 4 macro-areas:
1) Fiscal consolidation
- Migration to a stable primary balance at 4% of GDP by 2014
2) Fiscal structural reforms
- EUR50 bln privatization plan
- Taxation system reform: legal simplification and harsher and more efficient fight against tax evasion
- 150K reduction in public sector payroll by 2015 (15K in 2012)
- Pension and health care system reforms: long-term sustainability and modernization
3) Financial sector regulation and supervision
- Capital adequacy requirements: 9% Core Tier-I ratio by 2012Q2 (10% by 2013Q2), 7% in 2014 under a stressed scenario
- Recapitalization plan implemented y the Hellenic Financial Stability Fund
- Legislation overhaul for HFSF, HDIGF (Hellenic Deposit and Insurance Guarantee Fund), Bank of Greece and bank resolution mechanisms
4) Growth-enhancing measures
- Reduction of legal minimum wage by 22% (35% for young workers)
- Wage setting system reform (more flexibility in collective agreements)
- Fight to undeclared work and social contribution evasion
- Liberalization of a number of closed professions and service sectors (retail, employment agencies...), elimination of minimum fees charged by professionals, other competition-enhancing interventions
- Upgrade and reform of the education and judiciary systems
In total the supplementary measures on the spending side amount to €3.2Bn (1.5% of GDP). In addition, Greece will need to propose by June additional measures on the expense side for EUR11Bn spanning on the period 2013-2015.
Greek unit labour costs have risen in 2004-2011 26%, almost twice the Euroarea average (+14%). The Greek minimum wage is twice as high as in Portugal and six times higher than in neighbouring Bulgaria, where indeed many Greek companies relocated in recent times. Unsurprisingly, export shares and the current account have continued to deteriorate in the same period. A correction is certainly needed. Whether this will be reached via lowering minimum wages is unclear, considering that many Greek workers are already employed off the books and paid wages well below the legal minimum. Also, the lay-off of 150K public workers could add up to 4% to the unemployment rate. So, while these measures may produce competitiveness gains in the long run, will most likely exacerbate the drop in aggregate demand in the short run, putting ever more weight on an already moribund economy (Greek GDP declined 15% in real terms since 2007).
Voluntary PSI or not (and CDS triggered or not)?
We think it will be non-voluntary, with CAC, hence CDS triggered
We keep our view that the “voluntary” exchange is unlikely to lead to a participation rate that is high enough to convince the IMF. This means that a coercive option has to be chosen, hence the CAC voted by the Parliament. If CAC are imposed, the CDS will be triggered.
Will the ECB participate?
Yes, but not directly on PSI, just at cost.
On our numbers, the ECB had spent close to 40Bn to purchase Greek bonds (38.5Bn to be precise). It is obviously possible that our number are inaccurate, the exact figure has not been made available. However, if the actual figure is indeed above 35Bn as we think, it means that the ECB is not only transferring its portfolio at cost but also probably giving back the interest earned on the portfolio.
Again on our numbers, this would be a c1/3 haircut on the ECB portfolio nominal value. This means that it would not remove totally the seniority argument on the ECB portfolio, as the haircut supported by the ECB is considerably smaller than that of private investors. In our last piece we wrote “on balance we think the ECB will receive a haircut”, we were only half right: they did receive a haircut, but quite a smaller one than the market.
How will the bailout plan 2 work?
Out of the EUR110Bn earmarked for the first bailout plan, only 74Bn (the first 6 tranches) have been already disbursed. The rest will not be paid because the first plan has been discontinued and will be substituted by the new plan. This will be managed in the same way as the first, with quarterly payments conditional on a positive IMF/EU/ECB review.
What is the timing going forward?
15 FEB – EU finance ministers were supposed to meet in Brussels to sign off the second bailout plan. This has been postponed but a teleconference is still apparently planned. So a conditional approval could be issued in order for the PSI to be launched.
17 FEB – Last available date for setting the PSI according to MoF Venizelos.
20 FEB – The meeting of EU ministers due on Feb-15 has been postponed to Feb-20, this meeting will finally sign off the second bailout plan, conditional on Greek party leaders having signed a document committing to implement the plan whoever wins the elections scheduled in April.
20 MAR – EUR14.5Bn of Greek paper comes to maturity. Without the new bailout plan the Greek state will mostly be unable to repay. Note that there is a 7-day grace period, which can be followed by bank holidays. So the deadline could be extended a bit more than a week after March-20.
1 APR – Elections schedule. Date to be confirmed.
Is Greece saved?
No, but we could hope it is ring fenced.
We think the second bailout and PSI will not provide a lasting solution for Greece. This is for two reasons:
1) The bailout plan sets a very ambitious target, partly based on growth assumption we see as optimistic (see charts below). To stick to the plan, Greece would have to almost halve its deficit to 4.7% from 9% in 2012. We calculate the PSI to reduce interest payment by 1.7% of GDP this year, leaving an additional 2.6% correction needed. In 2014 Greece should again reduce its deficit from 3.9 to 1.4%. All this should happen amidst the worst recession since wartime, a fractured political system and rising social tensions. On top of this, the IMF assumes growth to come back to Greece as soon as in the next year. With no signs of adjustment, fleeing investments and further austerity, we see this as unlikely
2) Even assuming the plan will work out, Greece will find itself in 2020 with 120% debt/GDP and interest expenditures equal to 4% of GDP. Its debt sustainability in the long run will still be in doubt.
We do not see the PSI as saving Greece. As we repeatedly argued, the imbalances are too wide to be solved by any debt restructuring: budget deficit, external imbalances and international competitiveness to name a few. What this PSI might do (only “might”) is ring fence Greece. First because the private sector exposure will be cut by 70% via the PSI. Second because the recapitalisation of Greek banks will reduce the risk of the financial system imploding in Greece. Third, because after the PSI the issue becomes essentially an IMF “classical” programme: funding the deficit and rebalancing an economy.
So what’s next?
IMF playing very hard, possibly just walking away.
As expressed above the PSI does not solve the problem, but if we are right that it ring fences Greece, it means that the attitude of the IMF will change. The option envisaged by the IMF to just walk away, as they did with some countries in the past, was too dangerous before the recapitalisation of the banking sector. A Greek default with no recapitalisation of the banks would have left Greece with no option but to print its own money. When recapitalisation is done, the option for the IMF to just “walk away” becomes much more credible. We thus believe the IMF will be much more strict with Greece, will not tolerate slippage in deficit and we do believe that a premature termination of the Greek programme is a distinct possibility.
How this will be done? One idea that has been floated is to provide IMF funding via an escrow account that would first service the debt and then be used for the remaining part to fund the primary deficit. Greece would thus not get more than agreed during the plan.
The risk obviously is that, when Greece moves back to a primary surplus, the IMF/EC funding would be used only to fund interest payments. At this point Greece would have an incentive to cut debt service by reducing the coupon payments. We think there is a distinct possibility at this point to embark on a PSI-2 negotiation.
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