An extreme necessity: Greece officially requests aid from EU, IMF (Updates: Spain & Portugal Downgraded, Greece to 'Junk' status)

Bailing out Greece
An extreme necessity
Greece's request for aid from the euro zone and the IMF will provide only temporary relief

Apr 23rd 2010 | From The Economist online

GREECE’S prime minister, George Papandreou, faced the television cameras on Friday 23rd April to anounce that his government would draw on emergency aid to tide it over for the rest of the year. Mr Papandreou decribed the rather embarassing request to to other euro zone members and the IMF as “an extreme necessity.” This followed a week in which yields on Greek bonds reached an alarming 8.9%. That in part reflected an announcement by Eurostat, the European statistics agency, that Greece’s budget deficit reached 13.6% of GDP in 2009, even worse than it had previously thought. The agency added that the number might be revised up again, owing to the poor quality of the available data. Moody’s, a credit-rating agency, responded by giving the latest of many downgrades by agencies to Greece’s sovereign bonds.

The interest rate for emergency aid from other members of the euro zone will be 3.5 percentage points above the benchmark “risk-free” rates for euro loans. That works out at around 5% for a fixed-rate loan, which is less than markets were asking of Greece before the deal was struck but still steep. Portugal and Ireland, the next-riskiest borrowers in the euro area, pay less than half as much for three-year money. Germany pays a mere 1.3%.

The IMF is expected to make €15 billion available, at interest rates that are likely to be a little kinder to the Greeks. The resulting package of €45 billion should be enough to finance Greece’s budget deficit for the rest of this year as well as repay its maturing debts. Yet Greece is likely to need far more support than this as it struggles to put right its public finances.

An earlier analysis by The Economist suggested that Greece would need at least €75 billion of official aid. We based this figure on several assumptions: that Greece would need five years to stabilise its ratio of debt to GDP; that it could take the pain of a brutal fiscal retrenchment; that private investors would still be willing to refinance existing debts, at an interest rate of 6%, if a rescue fund covered the country’s new borrowing; and that the economy would start to grow again in 2013.

An updated set of projections is set out on the right. We have made two changes so the analysis is a bit rosier. We now assume that Greece cuts its budget deficit, as a share of GDP, by four percentage points this year, as planned, so it has less to do later. We also assume that the interest charged on all maturing and new borrowing is 5%, in line with the cost of the aid offered by Greece’s euro-zone partners. With those changes, we reckon Greece would need to cut its primary budget deficit (ie, excluding interest costs) by 12 percentage points to cap its debt burden—a slightly less fierce adjustment than in our first simulation. On that basis Greece will run up an extra €67 billion of debt by 2014, by which time its debt will stabilise at a scary 149% of GDP. That sum is less than our previous estimate, but still half as much again as the amount on offer.

Some will see this scenario as too pessimistic. It is far gloomier, for instance, than that envisaged in the EU retrenchment programme, which assumes that Greece will get its deficit below 3% of GDP in three years and that the economy can continue to grow as it does so. However, even with a more benign assumption about growth, Greece’s debts would still be very large. For instance, suppose that any losses in nominal GDP during recession are quickly recovered. Debt would still then stabilise at 142% of GDP.

It will be hard for Greece to make such savage cuts in its budget and emerge from recession at the same time. Furthermore, prices and wages will have to fall if Greece is to regain the cost competitiveness needed for sustained economic growth. That will drag down nominal GDP in the short term, and make budget cuts more difficult to carry out.

Our analysis may even be too optimistic. If economic growth does not return, deficit reduction proves too painful or interest rates are much higher than we assume, the debt ratio is likely to spiral upwards until default becomes all but inevitable. Even if that is avoided, Greece’s rescuers may have to shoulder more of the financing burden than we have estimated, should private investors reduce their exposure to Greece.

They have plenty of reasons to do so. As Greece’s debt mountain grows, investors are increasingly likely to shun its bonds in favour of those of other, more creditworthy, euro-zone countries. Though IMF cash is welcome, private investors know that the fund is first in the queue when money has to be paid back. A euro-zone rescue party may also demand priority.

The bolder sort of investor may reckon that the high yields on offer are ample reward for the risk that Greece may be unable to repay all it has borrowed. But some will be more cautious. And others may judge that an interest rate big enough to compensate for the risk of default would only add to the pressure on Greece, making default more likely. Asian central banks that want to balance their dollar holdings with euros may choose to park their cash in France or Germany and save themselves any worries about Greece and its politics.

Greece’s euro-zone partners could find themselves with a large and open-ended commitment to roll over the country’s existing debts and to provide cash to cover its budget deficits. The rescue package may over time evolve into a rolling series of soft loans, at ever-lower interest rates and increasing maturity, designed to prop up Greece and keep default at bay. Such loans—in effect, grants—would amount to a kind of fiscal drip-feed. That could spur a political backlash, and perhaps legal challenges, in the countries supplying the funds.
The default option

Is a sovereign default by Greece imaginable? Conventional wisdom has it that sovereign defaults are always messy and painful. In fact the lesson of such defaults over the past decade or more is that this is not necessarily so. More than a dozen emerging economies have restructured their sovereign debt in the past decade without huge losses of output and without paying enormous penalties in exclusion from capital markets or higher spreads. With a few exceptions (notably Argentina) the process has been much quicker than in earlier sovereign restructurings, and governments and creditors have managed to work together. Governments sometimes negotiated a restructuring with creditors before formally missing a payment of interest or principal—a process known, in the jargon, as “pre-emptive” restructuring. Legal innovations to encourage creditors to take part in restructurings and make it harder for holdouts to litigate have helped.

In 2003 Uruguay restructured all its domestic and external debt, exchanging old bonds at par and at the same coupon rate for new ones but stretching maturity dates by five years. The country returned to capital markets a month later. The “haircut”, or loss to bondholders, was small (13.3%, in net present value), as were the amounts restructured ($5.4 billion), but it showed that orderly sovereign workouts are possible. Countries such as Jamaica and Belize have had orderly restructurings recently.

Greece is different because it has much more debt outstanding and because bondholders may face a more severe haircut—although with sufficient fiscal consolidation a more modest restructuring could be feasible. Sovereign-debt lawyers say that in some ways a restructuring of Greek debt would be easier than many people think. But other things would be new and harder, especially the complexity caused by credit-default swaps, which have not yet played a big role in any sovereign-debt restructurings. It is uncertain, for instance, whether a pre-emptive restructuring would trigger the default clause in credit-default swaps. But Lee Buchheit, a leading sovereign-debt lawyer, says that the biggest risk in most debt-restructuring cases is governments that try to put off the inevitable. “By far the greater risk is pathological procrastination by the debtor in the face of an obviously untenable financial situation,” he argues, in which a country pursues frantic and ruinously expensive emergency financing in the lead-up to an eventual restructuring.

Would a defaulting country have to leave the euro? No. It is perhaps natural to conflate default with devaluation because they often occur together. But a euro member has no currency to devalue. Nor is there a means to force a defaulter out, since membership is meant to be for keeps. A new currency would have to be invented from scratch, a logistical nightmare. All contracts—for bonds, bank deposits, wages and so forth—would have to be switched to the new currency. The changeover to the euro was planned in detail and in co-operation. The reverse operation would be nothing like as orderly. A country that had lost the faith of investors in its public finances would find it hard to reconstruct a sound monetary system. Default by a member would be a body blow to the euro’s standing. But it need not spell the end of the currency.

5% is the 'bailout rate' for the EU....the market rate is 8.9%..but yes, they are getting a pretty nice 44% discount from the market rate.

update: Greece's bonds have been downgraded to 'Junk' status, and Portugal has been downgraded by 2 notches form A+ to A-..Euro is down today against the USD and Yen as a result.

Would S&P, Fitch, or Moody's use the same criteria to rate the U.S.debt?

not likely. They would be hauled in front of congress next.

and now spain is downgraded as well...This leaves only Italy left out of the PIGS group...so they are next.

It originally was Italy..but Ireland was added after the current financial crisis hit...sorry, it should be PIIGS [wikipedia.org] not PIGS

Athens, Greece (CNN) -- Greece accepted a bailout deal including tough austerity measures, Finance Minister George Papaconstantinou announced Sunday.

He did not reveal the size of the package negotiated with the European Central Bank, European Commission and International Monetary Fund, saying it would be announced in Brussels, Belgium, later on Sunday.

It includes a promise by Greece to cut its budget deficit to 3 percent of gross domestic product, as required by European Union rules, by 2014, he said.

Greece had a choice between "destruction" and saving the country, and "we have chosen of course to save the country," Papaconstantinou said.

The head of the European Commission Sunday praised the Greek government for committing to "a difficult but necessary reform process."

The program "constitutes a solid and credible package," Commission President Jose Manuel Barroso said in a statement.

Final details are expected to be announced from Brussels around 5 p.m. local time (11 a.m. ET), an EU representative told CNN.

The planned austerity measures are unpopular among Greeks. Protesters clashed with police Saturday during May Day demonstrations, and strikes have been announced for later this week.

May Day observed around the world

Papaconstantinou confirmed Sunday that the government would tighten its belt significantly, despite the protests.

"The expenses of the public sector will go down very considerably," he said.

The program includes cuts in the salaries of public-sector workers, including lawmakers, higher taxes on cigarettes, fuel, gambling and luxuries, an increase in the value-added tax consumers pay on purchases, and an increase in the retirement age for women in the public sector, Papaconstantinou said.

Prime Minister George Papandreou earlier Sunday tried to rally the country behind the government.

"I know that our compatriots are being asked to make big sacrifices, but the alternative way would be disastrous and painful for us," he said in a televised Cabinet meeting.

"It's not a pleasant decision for me, for any of us, but we are here to make the right decisions for our country," he insisted.

He spoke a day after Greek protesters clashed with police who fired tear gas during the annual May Day rally in Athens.

Waving red flags, the crowd at times surged toward the line of police, who wore helmets and carried riot shields. The police pushed them back each time.

Protesters threw objects toward police, and scattered fires were burning on the streets.

Seven police officers were injured, police said. Nine people were arrested -- three for attacks on police and six for theft from stores.

Twenty-seven people were questioned in connection with violence. A van belonging to state broadcaster ERT was set on fire.

About 12,000 people were protesting in Athens, and rallies were also taking place in the northern city of Thessaloniki, a police spokesman said.

Protesters there smashed two ATMs, the glass frontage of a bank, and a car, but no one was arrested or being questioned, the spokesman said.

The Greek government is facing a large deficit and massive debt, ultimately threatening the stability of the euro. The currency is used by 16 countries across Europe, including Greece.

Greece's national debt of 300 billion euros ($394 billion) is bigger than the country's economy, and some estimates predict it will reach 120 percent of gross domestic product in 2010.