Greek deal doesn’t dispel growth worries
Wednesday, 22 February 2012 | 11:00
Fears that added layers of austerity will undercut Greek growth and undermine efforts by Athens to slash its debt pile to
a sustainable level threatened to overshadow relief sparked by a long-sought agreement Tuesday to extend the country a second bailout, economists said.
The Financial Times reported Tuesday that a 10-page analysis of Greece’s debt sustainability prepared for the euro-zone ministers last week found that additional austerity measures being forced on Greece risk creating a recession so deep that Greece won’t manage to whittle down its debt load over the course of the new bailout.
The assessment goes a long way toward explaining the reluctance by Germany, the Netherlands and Finland to accept the latest bailout deal, which must still be approved by all euro-zone national parliaments — something that isn’t guaranteed, said Michael Derks, chief strategist at FxPro in London.
The euro initially popped higher after euro-zone finance ministers and international officials announced an agreement to provide Greece with 130 billion euros ($172 billion) through 2014. Greece will also launch a debt swap that will see private bondholders accept a 53% write-down on the value of their holdings of roughly 200 billion worth of Greek government debt.
The euro proved unable, however, to hold advances beyond the $1.33 level versus the dollar, paring gains to trade at $1.3218 in recent action.
European equities traded lower, threatening to end a four-day winning streak. The safe-haven German bund advanced modestly, while Italy’s 10-year government bond retreated, sending its yield up by around 5 basis points to 5.44%.
The path to the agreement was twisted and difficult, marked by delays and ultimatums. Financial markets, however, largely remained immune to the drama.
Although headlines drove intra-day fluctuations in overall risk appetite, equities managed to gain ground, the euro regained its footing to push back above $1.30 after an early January swoon and Italian government bond yields — the true battleground of the debt crisis — fell sharply from panic highs seen late last year.
“I think the market to some extent had already left behind the subject of Greece,” said Piet Lammens, fixed-income strategist at KBC Bank in Brussels.
That has a lot to do with the European Central Bank’s decision in December to flood the financial system with long-term liquidity, providing 489 billion in three-year loans to more than 500 banks through a long-term refinancing operation, or LTRO.
A second three-year LTRO is set for the end of the month. The move, along with other liquidity-aiding measures, served to ease funding pressures for European banks. As fears of a funding-related bank collapse faded, investors increasing appetite for risky assets.
Meanwhile, fears of a sharp euro-zone recession have also faded, Lammens noted, though the jury remains out. Delivering growth across the euro zone, which saw a 0.2% contraction in gross domestic product in the fourth quarter, will be crucial to helping ensure Italy and other vulnerable sovereigns keep debt on a sustainable path, he said.
At the same time, investors won’t be able to ignore Greece.
The debt sustainability report warned that the potential for slippage was significant.
In one downside scenario included in the report, Greek debt could fall to only 160% of gross domestic product by 2020, falling far short of the target of 120% set by the International Monetary Fund, the Financial Times reported. It’s possible that Greece could need another 50 billion in funds by the end of the decade, the report said.
Greece also faces an expected election in April.
“With the economy currently in its fifth year of recession and already contracting by 7% year-on-year in the fourth quarter, even the revised debt sustainability analysis looks optimistic,” said Janet Henry, economist at HSBC.
And since Greece will remain subject to quarterly reviews of its compliance with the terms of the program, investors could be back to worrying about whether Greece will receive its next tranche of funds by summer, she said.