Does anyone remember Greece’s sovereign-debt crisis?
Between all the headline-grabbing events of the past year—both political and economic—the world hasn’t been able to catch a break. The Greek saga, which continues to ebb and flow, deserves a reminder—but for more reassuring reasons this time: Greece appears to have satisfied most of its creditors’ conditions for receiving a third round of bailout money.
But first, a quick recap.
How We Got Here
Greece’s sovereign debt crisis began in late-2009 and was sparked by the Great Recession, structural problems in the Greek economy, and revelations that its government debt level had been misreported.
The country has embarked on multiple bailout programs since 2010, when private-sector investors effectively lost faith in Greece’s ability to service its debt. It signed on to its third and current program in the summer of 2015 after very tense negotiations with its creditors. The absence of an agreement at the time would have meant the departure of Greece from the Eurozone and the introduction of its own currency. That crisis was avoided, and Greece entered the third program, scheduled to end in August of 2018, with loans up to €86 billion.
As is common in such national bailout programs, loans are released in installments and subject to a set of conditions. Greece has to meet these conditions—which include fiscal reforms, structural measures and quantitative performance targets—and is subject to periodic reviews of progress by its creditors, which it needs to pass successfully.
Greece has already finalized (i.e., successfully passed) one such review in May 2016. The second is currently underway and being finalized, though it is several months overdue. So far this year, Greece’s government hasn’t had any pressing needs for funding, but by July it will have to pay more than €7 billion in obligations. This means that Greece will need to pass its second review before mid-July so that it would be able to obtain additional loans from its creditors that will enable it to pay down its debt.
- The good news is that at an April meeting of the Eurogroup—the group of Eurozone finance ministers overseeing and approving the loan program—Greece reached an agreement on the measures it needed to take for the successful completion of its second creditor review. This agreement came after Greece’s government agreed to enact reforms in state pensions, the labor market and the energy sector, and raise the threshold of non-taxable income to increase tax revenue. For Greece, these were politically difficult measures to take, but once Greece agreed to them, the next step was to send representatives of the European Commission and International Monetary Fund (IMF) to iron out the technical details of the agreement and make sure the numbers add up.
- Last week, the Greek parliament passed the necessary legislation to enact the reforms and pass the second review. As of now, the second review is not yet deemed successful and complete—not because Greece has failed to live up to the conditions of its creditors, but because of disagreements between Greece’s creditors and the IMF (which we’ll get to shortly). However, we believe the second review will be completed successfully before July (when Greek’s debt payments are due) and possibly at the Eurogroup meeting scheduled for June 15.
- Though the bailout program will fund Greece in the near term, questions loom over the country’s fiscal sustainability and ability to meet its longer-term obligations. Eurozone countries agreed to reduce that long-term burden if Greece passes the current bailout program successfully by the summer of 2018. However, as mentioned previously, the creditors are in disagreement.
Germany, The Netherlands and other creditors are now insisting that the IMF participate in the bailout program. However, the IMF is unable to do so because, according to its projections, Greece’s debt is unsustainable over the long run and is not eligible for support under the IMF’s rules. The IMF argues that Greece would be unable to reach the primary fiscal surplus required by the bailout program because the conditions it needs to meet would restrict economic growth. According to the IMF, Greece needs more than just a bailout: It needs debt relief.
Though the Eurogroup did promise debt relief, the IMF has deemed the terms and conditions of such relief too vague—hence the disagreement between Greece’s European creditors and the IMF.
- Debt relief is a politically unpopular measure for Greece’s creditors and we don’t think concrete steps can be taken on that front before the German elections. But there could be an interim solution that would enable the IMF’s involvement in the bailout. For example, according to reports in the media, one possibility is that the IMF enters a program without providing financing until the program ends and creditors grant debt relief. Alternatively, the parliaments of Greece’s creditors (including Germany’s) may get approval to grant Greece a pass on the second review without IMF involvement. Our key point here is that Greece has met its obligations, and it cannot be penalized simply because of a disagreement among its creditors.
Where Do We Go from Here?
The path forward is challenging but, we believe, less so than before. Greece has already swallowed the bitter pill of 2015 when agreeing to the austerity measures it had to take in order to receive bailout money from its creditors. We also believe that Greece has overcome most of the bailout program’s major obstacles and will be able to pass future reviews by its creditors more successfully.
Additionally, Greece’s ruling party—the Syriza party of Prime Minister Alexis Tsipras—is significantly behind the current opposition in the polls. The best way for the party to improve its standing is to preside over an economic recovery and a successful completion of the bailout program. We believe such recovery is possible given the major structural reforms Greece has undertaken to strengthen its economy, and given that gross domestic product (GDP) growth has already declined significantly and has a very low base from which to rise.
At a critical point in Greece’s debt crisis in 2015, the Greek government made a decision to remain in the Eurozone. Prime Minister Tsipras resigned after signing on to the current bailout program, and called for snap elections. His victory granted him a clear mandate to pursue the bailout program. Since then, we have maintained a long position in Greek bonds while closely monitoring economic and political developments in the Eurozone.
The yield on 10-year Greek government bonds declined from more than 8.5% last year to 5.7% this week (Exhibit 1). Further capital gains from Greek bonds are possible, in our view, but even without them, current yields look attractive given what we see as relative stability in Greece.
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