Bloomberg News

EU Preparing New Greek Rescue After Aid Payout Approved

June 04, 2011

(Adds private-sector contribution report in 12th paragraph.)

June 4 (Bloomberg) -- European Union officials will focus on preparing a new aid package for Greece that includes a “voluntary” role for investors after the EU and the International Monetary Fund approved the fifth installment of Greece’s 110 billion-euro ($161 billion) bailout.

“I expect the euro group to agree to additional financing to be provided to Greece under strict conditionality,” Luxembourg Prime Minister Jean-Claude Juncker said after meeting with Greek Prime Minister George Papandreou in Luxembourg on June 3. “This conditionality will include private-sector involvement on a voluntary basis.”

Papandreou agreed to 78 billion euros in additional austerity measures and asset sales through 2015 to secure the 12 billion-euro bailout payment and meet conditions for receiving an additional rescue package. He agreed to make “significant” cuts in public-sector employment and establish an agency to manage accelerated asset sales, according to a statement released in Athens on June 3. The plan is fueling popular opposition and protests across Greece.

Greek bonds gained on the prospect of a new aid plan, with the yield on the country’s two-year notes falling 172 basis points yesterday to 22.8 percent, the lowest since April 20. The agreements came at the end of a week when Greece’s fiscal crisis worsened enough for Moody’s Investors Service to raise the probability of a default to 50 percent.

‘Debt Problem’

“The current discussions over the Greek debt problem have arisen mostly because of a realization that Greece won’t be able to raise money through normal bond issuance in 2012,” said Justin Knight, an analyst at UBS AG in London. “The choice for policy makers is one between funneling more aid funds into Greece to avoid default next year and restructuring debt now so that funds due to be paid to Greece under the current plan can last longer.”

A year after the rescue that aimed to stop the spread of the debt crisis, Greece remains mired in a third year of recession, shut out of financial markets and saddled with the biggest debt load in the euro’s history. Ireland and Portugal followed in seeking bailouts and Greece now needs a second rescue package to avoid the euro area’s first sovereign default.

Under the original rescue, Greece was due to sell 27 billion euros of bonds next year. EU leaders and Papandreou have acknowledged that a return to markets won’t be possible with Greece’s 10-year debt yielding 16 percent, more than twice the level at the time of the bailout. The EU is looking to close that funding gap through new loans and bondholders’ willingness to roll over Greek debt, EU officials have said.

IMF Funds

Europe’s financial leaders needed to hammer out a revised Greek package to persuade the IMF to pay its share of the 12 billion-euro tranche originally due in June. The IMF had indicated that it would withhold its 3.3 billion-euro piece unless the EU comes up with a plan to close Greece’s funding gap for 2012. The EU-IMF statement said the full payment would be made in early July.

The Washington-based lender provided 30 billion euros of Greece’s original loans, along with a third of the loans since granted to Ireland and Portugal.

Policy makers have in recent days narrowed in on bond rollovers as a pillar of any new aid package. The step would be favored by the European Central Bank, according to two officials familiar with the situation, as it would reduce the risk of any agreement being classified as a default. Investors may be given preferred status, higher coupon payments or collateral, said two other EU officials familiar with the situation. EU leaders are due to meet in Brussels on June 23-24 to approve a plan.

Spending Cuts

About 55 percent of investors in Greek government bonds would likely roll over holdings of securities maturing through 2013 to help the nation manage its budget deficit, according to ING Groep NV.

Euro-region governments have reached a tentative agreement on a package in which the nation’s private-sector creditors will contribute about 30 billion euros, the Wall Street Journal reported today, citing unidentified senior euro-zone officials. The process of exchanging current debt for longer maturity replacements might begin as soon as July, the Journal said.

Papandreou is promising 6.4 billion euros of spending cuts this year, another 22 billion euros up to 2015, and 50 billion euros in sales of assets including Hellenic Telecommunications Organization SA and Public Power Corp SA. The pledges aim to get the deficit down to 7.5 percent of gross domestic product and were key to securing the fifth bailout payment. Papandreou is facing a backlash against the additional measures at home.

Market ‘Turn’

Members of the PAME labor union took over the Finance Ministry offices in central Athens yesterday, preventing employees from entering the building. They hung a banner from the roof calling for a general strike to oppose the measures.

A group of 16 lawmakers from Papandreou’s Pasok party this past week sent the premier a letter asking for a discussion of the austerity process. Papandreou will present the plan to lawmakers and his Cabinet in the new week. Workers at state- owned companies are organizing a 24-hour strike on June 9.

Moody’s downgraded Greece to Caa1, on a par with Cuba, and raised the nation’s risk of default on June 1 after policy makers considered asking investors to reinvest in new Greek debt when existing bonds mature. The move prompted Greek 10-year bonds to fall to the lowest since January.

‘New Territory’

“When more details will be available and we will get declarations that a deal has been reached, we might see a turn in bond markets,” said Chiara Cremonesi, a fixed-income strategist at UniCredit SpA in London. “The risk here is that they find a solution to fix the problem temporarily and don’t address it structurally.”

“The general perception is that Greece will head to some form of restructuring, and eventually the ratings will probably move to D,” said Brian Barry, an analyst at Evolution Securities Ltd. in London. “For a sovereign rating to fall from about A to this level is new territory.”

Moody’s on June 3 cut the ratings on eight Greek banks, including the nation’s largest, National Bank of Greece SA.

The austerity measures have choked growth, shedding doubts on whether Greece will generate the tax revenue to pay off its debts. The economy if forecast to shrink 3.5 percent this year after contracting more than 4 percent last year. Some economists including Nobel-prize winner Joseph Stiglitz said the country would be better off if it restructured its debt.

Buying Time

“Hopefully they will go forward with an orderly restructuring -- that is the only way to restore growth with equity,” the Columbia University professor told a conference in Sitges, Spain, on June 3. Austerity will not bolster growth, “but is only a step to the disorderly restructuring that will almost inevitably follow,” Stiglitz said.

The EU program is aimed more at protecting Europe’s banks, than helping Greece, he said.

The new aid and debt rollovers will give Greece more time to trim its budget deficit, though will do little to reduce its rising debt load. Greece’s debt is likely to mushroom to 157.7 percent of gross domestic product in 2011, the highest in euro history, the European Commission said on May 13.

The aid package may be more about buying time for Europe’s banks and other high-debt nations to prepare for the fallout of a Greek restructuring, said James Nixon, chief European economist at Societe Generale SA in London.

“This strategy of playing for time is not without its merits,” he said in a note to investors on June 3. “It buys a number of the other Europeans time to put their own house in order and pursue their programs of fiscal consolidation. Time hopefully will also help Europe’s banks provision against future losses on sovereign debt. Finally and perhaps most critically, time also enables the peripheral economies themselves to implement fiscal reforms and return to a primary balance.”

Juncker rejected the worst-case scenario.

“It’s obvious that there will be no exit of Greece from the euro area,” he said. “There will be no default and Greece will be able to fully honor its obligations.”

--With assistance from Emma Ross-Thomas in Madrid, Simone Meier in Zurich and Natalie Weeks in Athens. Editors: Andrew Davis, Jeffrey Donovan

To contact the reporters on this story: Jonathan Stearns in Brussels at jstearns2@bloomberg.net; Maria Petrakis in Athens at mpetrakis@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net


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