The Importance Of Being Earnest - FTSE

out, or at least significantly impair, the
fresh core capital the banks have raised
to strengthen their balance sheets in
the wake of the financial crisis and once
more leave them vulnerable to collapse.
The longer the EU authorities can
postpone any sovereign restructuring
through bailouts, the better the chances
that banks will be able to build up sufficient
profits and reserves in the
meantime to cope with the hit when it
comes. “I’m sure that’s one of the
reasons they’re trying to postpone it as
long as possible,” says John Stopford,
head of global fixed income as Investec
Asset Management.
The necessary aid up to 2013 will
come from the €440bn European
Financial Stability Facility (EFSF) that
EU member countries set up in May
2010 to calm market fears that the currency
was about to implode. After that,
it will come from the European Stabilisation
Mechanism (ESM), which is
designed to replace the EFSF on a permanent
basis.
Can Greece avoid restructuring?
In the case of Greece at least, however,
it is clear that the market does not
believe the evil moment can be put
off for much more than another year
despite recent statements to the contrary
from senior Greek and EU
officials. The country’s sovereign debt
has been trading at about 50% of par
for several months, and the yields on
ten-year bonds hit an all-time high of
13.83% on April 15th this year. Four
days later, the government had to offer
a yield of 4.1% to sell €1.625bn of 13week
treasury bills. “If you look at the
current yields on Greek debt, I think it
is clear that everyone assumes Greece
is not going to be able to repay it,”
said Professor Ben-Gad. “It is therefore
fair to assume that there will be a
restructuring.”
It is difficult to fault the market’s
logic. The country’s gross national debt
now stands at €340bn and is expected
to rise from 152% of GDP this year to
157% in 2012. With inflation and
unemployment rising and GDP con-
F T S E G L O B A L M A R K E T S • M AY 2 0 1 1
Professor Michael Ben-Gad, head of
economics at City University London. “If you
look at the current yields on Greek debt, I
think it is clear that everyone assumes Greece
is not going to be able to repay it,”he says.
Photograph kindly supplied by City
University London, April 2011.
tracting, it will soon become impossible
to service this level of debt and maintain
essential government services. The
recently agreed 1% cut in the interest
rate on €110bn of emergency loans that
the EU and IMF advanced to Greece
last year and the €50bn privatisation
programme that the government
announced in April will not be enough
to bridge the widening gap in the
public finances.
“While I think restructuring is very
much the last resort, we’ll probably get
there with Greece next year,” says Justin
Knight, head of European rates strategy
at UBS in London. “When the country
runs out of money, it’s either debt
restructuring or a second aid package.”
At some point in 2012, Greece will
exhaust the EU/IMF aid and unless
further EU assistance is forthcoming via
the EFSF, the government will at that
point have no further access to external
finance. Its priority will then be to ensure
that it has sufficient tax receipts to cover
the vital functions of government, and
repayment of foreign debt will go on
hold. Any rescheduling/restructuring
plan that subsequently emerges is
certain to involve considerable writeoffs,
and the leading question is who
will bear the cost?
The hope of the euro’s supporters, led
by Germany and France, is that the
mechanisms of the EFSF and later the
ESM will allow the pain to be spread as
widely as possible and so mitigate the
impact on individual investors, particularly
commercial banks. To be able to do
this effectively, however, the EFSF would
need to be able to buy the sovereign
debt of distressed countries and there
was no indication of political consensus
for such a step at the EU Council
summit on March 24th and 25th, which
deferred decisions on expanding the
remit of the EFSF until June.
Knight at UBS said it would be vital to
effect such change ahead of any defaults
in the eurozone. “If the expansion of the
EFSF is not in place by then, the crisis
could go from bad to critical within a
very short space of time,” he warns.
Holding off a political backlash
Far from the EU membership moving as
one in this direction, however, it is a
political backlash against bailouts of the
more profligate member states that currently
appears to be gaining momentum
across Europe. In Germany, for example,
the ruling CDU party lost its former
stronghold of Baden-Wuerttemberg in
the state election during the final week
of March to an alliance of Greens and
Social Democrats. This will further
weaken Chancellor Angela Merkel’s
ability to support the peripheral eurozone
countries (although the election
setback itself was attributed more to the
CDU’s energy policy than its support
for bailouts).
More recently, the success of the
anti-bailout True Finns party in
Finland’s parliamentary elections on
April 17th (more than tripling its share
of the vote to 19%) threatens to have
a more immediate impact, as it has
put a question mark over whether an
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