THE second financial bailout package of Greece was finally signed between Greece and the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF). The key terms are: Greece will get €130 billion of which €50 billion will go for the recapitalization of domestic banks in Greece.
Private holders (mostly banks and funds) will exchange their holdings of sovereign Greek bonds into a combination of new longer-term bonds (11-20 years) and short-term cash secured bonds at an exchange rate of 46.5 percent of the face value of their current bond holdings which implies a 53.5-percent “haircut.” This haircut does not include the haircut in terms of the much-lower yield than the market over the life of the new bonds that the private sector bondholders have to accept.
Greece commits to bring down its debt to GDP ratio from the current 160 percent of GDP to 120.5 percent of GDP by 2020 through a series of austerity measures including government spending, wage and social benefit cuts. The major political parties had to agree to honor the agreement whoever came into power. The Greek legal framework will also be amended to give priority to debt servicing.
The Unanswered Questions
THE immediate effect of the agreement for the second bailout of Greece is that €18 billion of its sovereign debt falling due in one month’s time will be serviced and a default of Greece will be averted. This brings a collective sigh of relief to Europe and the whole global markets and has renewed investment appetite in financial assets throughout the world. The Dow Jones index reached the 13,000 mark a couple of days after the agreement and the Philippine Stock Index has been hitting all-time highs in the past week. However, several questions come up or linger.
The first question is: Will this bailout do it or be enough to bring Greece eventually into being a healthy member of the Eurozone? The general thinking seems to be that this will not be enough by itself. Even if Greece is able to attain the 120.5-percent debt to GDP ratio in 8 years, a 120.5-percent GDP to debt ratio itself is still a difficult situation to be in. The issue is what needs to be done by Greece to prevent a third debt crisis from occurring and the need for another bailout.
Another question is for some members of the Euro zone countries to get the required approvals from their respective parliaments. At least 90 percent of the private holders of Greek bonds should also approve the package in order the avoid the need for complicated legal action.
A big question mark still hangs over Europe itself. Will the bailout package for Greece create a moral hazard in other debt-laden member countries going for a similar package? Or will private investors have become so adverse to investing into debt-laden Euro zone countries so that the financing costs go up?
There are many other questions and the only clear answer is that the way ahead is uncertain. The economic managers have many tools at their disposal. The ECB paved the way by auctioning off about €500 billion of three-year money at one percent interest rate per annum to the European banks. This gave European banks a lot of liquidity and led to more investments in Italian and Spanish sovereign bonds which propped up their prices, thus leading to lower costs of their respective borrowings. This move improved the general investment appetite for European bond issues. The ECB is planning to do another such auction of three-year funds at one percent and this should sustain a positive investment climate in sovereign bonds. However, the medium- to long-term solution to Greece and Europe will be how to attract a critical mass of voluntary investments back into Greece and the other problem countries of Ireland and Portugal based solely on fundamental risk and reward considerations. This is the greater challenge and the putting together of this second bailout package for Greece will look easy compared to what lies ahead.
* Written by PDIC President Valentin A. Araneta for Free Enterprise and published in the Businessmirror on February 29, 2012. Mr. Araneta writes for the Free Enterprise column as a member and officer of the Financial Executives of the Philippines (Finex). Requests for his past articles may be coursed through email@example.com.