After the excitement surrounding the so-called rescue plan for Greece last week that was launched by the Euro zone it would appear that Greece wishes to react quickly to events and issue some new funding. This will be a test for Greece on various levels and will give us a clue as to how she will get through the rest of this year. The head of the Greek debt agency Petros Christodoulou was quoted by the Financial Times as saying ““We would like to return to the market within March” and he estimated that the issue would be 5 billion Euros in size.
Those in charge of Greece’s finances have something of a dilemma in my view as their country needs funding whilst this new package has only improved her bond yields at the shorter end. So they are likely to be forced into a choice between cheaper short-term issuance and the stability of a longer-term issue. Also if one is to believe the public statements of Petros Christodoulou that the aid package “should tighten the spreads materially” then it would be logical to wait as long as possible. Of course the truth is he probably doesn’t believe that either!
Amidst all the talk of a positive response to the Euro zone rescue plan for Greece the truth is that ten-year bond yields have not fundamentally improved. On Friday Greek ten-year bond yields closed at 6.18% which is +3.02% over Germany’s so virtually double Germany’s bund. If we go back to the beginning of this month they closed at 6.27% and have climbed as high as 6.4% on a closing basis during it. This morning the yield has risen a little to 6.21%. Hardly a ringing endorsement.
For shorter-dated instruments there has been a more significant improvement. If one looks at two-year Greek government bonds the yield closed on Friday at 5.2% which when compared to a close of 6.11% on the 1st March does show an impact from the rescue deal.
Borrowing short must be tempting for Greece however it is something of a Faustian pact because it would have to be refinanced itself in short order. In itself such a move would betray a lack of confidence so whilst Greece might love to issue as cheaply as possible she knows that it is risky.
Whilst looking at the numbers I was reminded of something quite revealing. If you look at Germany she can borrow up to February 2015 so virtually five years at 2.20% assuming she could refinance at Fridays close. She has a 20 month bond yielding 0.90%! Now look again at Greece’s 5.20% for a two-year bond. What it shows us is a measure of how Greece’s government had lost control of financial markets. You see governments and central banks can control and have a lot of influence over shorter-dated paper and yet Greece still has to pay a high (if improved) yield. For those interested in the UK our we have several two-year government bonds and a typical yield on them is in the range 1.3/1.4%, so here is some good news for us we have retained some discipline here.
The Cost to Greece
Let us say that Greece does issue a ten-year bond and has to pay 6.18% on it. If she issues 5 billion Euros she would have to pay some 309 million Euros a year in interest. By comparison Germany would pay 158 million Euros a year in interest. Over this life of the bond she would currently pay around 1.5 billion Euros less in interest. Ouch.
If we go to shorter-dated issuance paradoxically whilst Greece can issue more cheaply in outright terms the differential with Germany is nearly 4%. So a 5 billion government bond issue would cost Greece around an extra billion Euros over its lifespan when compared with Germany.
In reality Greece has had to pay more than her current yields when she has issued government bonds this year and the size of this excess has been in the range of an extra 0.25/0.5% per annum. In another form this too is a sign of her crisis. Also I wish to make clear that Greece simply cannot afford these interest payments and have written on this subject in previous articles. She will have to spend 11% of her public spending on financing her debt and in a time of austerity this will be felt.
Issuance Required Going Forwards
By the end of April Greece needs to issue some 12 billion Euros worth of debt as she has bonds maturing worth around 8 billion Euros and short-dated paper (Bills) of 4 billion Euros. In May a ten-year bond matures and the cost of financing it will be 8.5 billion Euros. Once we get into June then a sigh of relief may be due as there are no further major refinancings due in 2010.
To pay for new borrowing will cost 2 billion Euros a month on average.
Having considered the way that events have unfolded since the announcement of a rescue plan for Greece there really only is one conclusion. Any improvement in her circumstances fits exactly the change in collateral rules that the European Central Bank announced last week much better than the so-called rescue plan which has been trumpeted by Europe’s politicians. Now that Greece’s government bonds will be accepted as collateral by the ECB in 2011 there is a clear and direct link in my view to the improvement in her shorter-dated government bonds. If you think about it the immediate future for the profitability of Greece’s banks looks much better too. After all if you can borrow at 1% from the ECB and deposit a government bond yielding much more in return then we have found an example of what those in the markets call “free money”. A credible rescue plan would have improved longer-term yields too.
You are probably wondering what Greece should do if she does issue a bond this week (which is not guaranteed as Mr Christodoulou has contradicted himself already once or twice which is quite an achievement considering his length of tenure in his job). In my view if logic applies she should borrow short in say the 3/4 year sector and cross her fingers for better days. If you take the official view that rates should fall due to the impact of the rescue plan then they should also borrow for a shorter time.
The rescue plan itself has been changed somewhat over the weekend. Presumably it was pointed out that it was very unwieldy and inflexible (rather a weakness for something which should be flexible) and now we are being told that should the crisis develop the International Monetary Fund would take the lead if help is required. I think that it speaks for itself that a self-styled long-term rescue plan could not get past one weekend without being modified!