Tuesday, April 13, 2010
Greek Bailout Plan May Be Template for the PIIGS
Last weekend, European leaders agreed to provide Greece with up to $41 billion in aid – if requested - to meet its giant debt obligations.
Under the plan, Greece would receive three-year loans at about 5% interest. Though Athens had wanted an even lower rate, beggars can't be choosers.
However, the rate is still significantly lower than what the markets were demanding last week.
The yield on 2-year Greek bonds had recently soared from 5.2% to 7.5% in a single week, to an 11-year high.
In addition to the $40 billion in European Union aid, the IMF will offer up to $20 billion in additional funds, probably at an even lower interest rate.
The hope is that the huge financial commitment, which exceeded market expectations, will at least postpone the need for aid by reassuring investors. Greece needs to refinance $20 billion (11.5 billion euros) of debt that comes due by the end of next month.
Greece has not yet made a formal request for aid, and hopes to avoid drawing on the EU and IMF money. Instead, it continues to turn to the capital markets, which may work for a while.
The future cost of government borrowing fell sharply in Athens today, and the danger of default receded, if only temporarily.
Greece was able to auction 1.56 billion euros worth of six and 12-month treasury bills today. However, the markets didn't seem entirely reassured.
The interest rate was punishingly high compared to Greece's previous short-term debt auction; the yield on the six-month bond was 4.55%, while the 12-month bond was 4.85%. Both yields are more than twice what they were in January.
However, they were still lower than the 5% offered under the EU bailout offer. And the demand for both was very heavy.
Due to the perceived risk of it defaulting on its debts, Greek borrowing costs are much higher than its eurozone partners.
Greece had been hoping that the rescue package offer would restore market confidence and drive rates down. The government has said it cannot go on paying elevated market interest rates as it seeks to roll over its debt obligations and avoid default or a bailout.
The Mediterranean nation still has to borrow around 11 billion euro ($14.9 billion) next month, and around 54 billion euro ($73 billion) for the year.
Analysts are concerned that the country's weak growth prospects may prevent it from paying off its enormous debt burden in coming years.
However, no one seems to be asking how taking on even more debt will help the Greeks solve their debt problem.
After adopting the euro nine years ago, Greece saw its interest rates drop to German levels. Subsequently, the Greek government – and Greek consumers – responded by going on a borrowing binge.
Sound familiar, America?
All 16 eurozone nations would take part in any rescue, with contributions based on the proportion they pay into the European Central Bank's capital reserves, which are roughly based on the size of their economies.
That means Germany would shoulder the biggest share of any rescue package and could be asked to contribute more than 6 billion euros.
However, even countries such as Portugal, Ireland and Spain – who are all facing their own economic difficulties resulting from massive debts – have agreed to participate in any potential Greek bailout.
The concern of the other eurozone nations is that this could create a template for the future bailouts of these debt-stricken European nations as well.
Perhaps that's why Jean-Claude Juncker, head of the eurozone finance ministers, described the weekend aid decision as "a loaded gun."