Greece: from solvency to liquidity risk

Posted on 25. avr, 2010 by Jean Jacques Ohana in Weekly Focus | Commentaires fermés

We have highlighted in our macro-economic perspective of G10 sovereign debt issues that Greece  follows an unsustainable public debt path as well as Portugal, Spain and in a more remote future the UK, the US and France.

In the last days, the Greek debt crisis has taken a new turn as the  spread between the Greek short-term and long-term yields has  become sharply positive:

As of 23 April, the 2 year Greek yield stands almost 200 bps above the 10 year yield.

As stated by JP Morgan research, more than 60% of the Greek public debt matures within the next 5 years with 180 Billion Euros needing to be refinanced within the next 4 years (75% of annual GDP).

The implication of this new development is twofold:

  • Greece is now facing a major refinancing issue. The release of 45 Billions EUR aid from European countries and IMF will help alleviate this liquidity problem in the next few months but it won’t fix the liquidity risk beyond this term.
  • The Greek debt service is sharply increasing and will spread quickly to the whole Greek debt (60% of this debt will be refinanced at very expensive rate within the next 4 years). At an average cost of debt of 6%, the Greek nominal GDP needs to grow at more than 6% rate to keep pace with the interest rate burden  in order for Greece not to fall into an irreversible debt trap. As a nominal growth above 6% seems a remote scenario, the only solution for Greece is to run a primary budget surplus exceeding the interest payment cost. Such a goal won’t be reached without social pain. Which country would accept VAT increase, pension reduction and wages cut without a social outburst?

Whereas the liquidity issue may be resolved through an inevitable restructuring of the Greek debt, the solvency issue may be addressed by temporarily excluding Greece from the rigid monetary system of the euro-zone and resetting the Greek Drachma against the Euro. This very strong medicine would alleviate the pain for the population by restoring Greek competiveness while increasing inflation and nominal GDP.

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