Greece Deal, but No Closure

Currency in Crisis
A Greek deal has emerged from the marathon meeting of European finance ministers, but it is far from clear that it ends even this chapter of the saga.  Attention will turn to the participation in the PSI.  The agreement struck appears to be more onerous than initially anticipated, with a 53.5% loss of notional value rather than the 50% previously agreed and well above the 22% envisioned initially and lower coupons on the new bonds.  

Part of the deal also includes reduction in the interest rate on the previous international assistance and there is not reason why those lower rates should not apply to Ireland (which is seeking relief on promissory notes used to recapitalize its banks) and Portugal.  Perhaps most importantly, the package does not give confidence that this solves Greece's problems, even if PSI is acceptable and Greece actually does implement the agreements.

The agreement stands on two legs--austerity and debt restructuring.  The clear and present risk is that these measures prolong the economic downturn and that another aid program is needed in 1-2 years.  In addition, the economic demands on Greece have undermined its political stability.  

In effect, Germany's controversial proposal  for a EU Commissioner and making debt servicing the top priority born fruit in the form of a European Commission task force being embedded in Greece in an "enhanced and permanent presence on the ground" to improve the workings of Greece's bureaucracy.  An escrow-like account is also being established that prioritizes Greece's solvency (ability to service its debt) over the other demands on the government's budget.  

Of the 130 bln euro aid package, the vast majority (roughly 85%) is being used to bail out lenders not bail out Greece.  Specifically, 30 bln euro is for the cash component of the PSI, 35 bln euro is to fund the government's purchase of bonds held as collateral by the ECB.  Another 40 bln is to recapitalize Greek banks, on top of the 10 bln earmarked from Greek 1.0 that has not been used.  

Another 6 bln euros is need to payoff the accrued interest on the bonds to be swapped.  EU officials have admitted they under-estimated the challenge presented by the weak administrative capacity and weak political unity in Greece.  Not only do they appear to be risking repeating this mistake, but also of bleeding the patient they hope to save by pursuing the pound of flesh in the name of the creditors.  

The euro initially moved higher when the deal was announced, but the $1.33, the upper end of the well worn range proved sufficient and the single currency has been pushed lower.  Support is seen near $1.3180 and a convincing break could see another cent decline.  European shares have come off, with financials and industrials the weakest sectors in the Dow Jones Stoxx 600.  European bonds are narrowly mixed, though of note, Spain and Italian bonds are firmer and the former's bill sale was well received.  
Greece Deal, but No Closure Greece Deal, but No Closure Reviewed by Marc Chandler on February 21, 2012 Rating: 5
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