Back in the market

IFR SSA Special Report 2018
11 min read

By proving it can access the debt markets in February, Greece has passed an important milestone on its journey back to economic normalisation. But while the country now has more options available to it, taking on new debts to pay off old ones is no long-term solution to its problems.

Greece’s economic troubles can feel reminiscent of Sisyphus, the ancient king of Ephyra. Sisyphus was condemned to spend an eternity rolling a heavy boulder up a hill, knowing once he reached the top it would inevitably roll back down. The country’s goal of one day paying off its vast debts often feels similarly unattainable. But unlike Sisyphus, Greece is denied even the temporary satisfaction of reaching the top of the hill.

Greece has done more than any other bailout recipient country – and by extension any country in the eurozone – to reform its economy. Yet, for all its hard work, it remains the laggard of the continent, the distance to the summit remaining dauntingly insurmountable.

Jesus Castillo, senior economist at Natixis, said: “Greece’s economy looks far healthier than it did three years ago, but each indicator still gives its own reason to be pessimistic. Debt is still high and unemployment is nearly 20%. GDP is growing but the investment rate is only 12% of GDP, compared to around 22% 10 years ago. It is still not clear, for an investor considering lending to Greece, what its future growth model is.”

Politically, in particular, Greece has made important progress. The mood ahead of forthcoming elections is relatively buoyant and support for anti-establishment parties is down.

“The opposition party is leading in the polls by 10% but is pro-European, so there is no obvious threat to the status quo,” said Ionnis Sokos, rates strategist at Nomura. ”There is no talk in Greece, the EU or the IMF about Grexit. Political risk is the lowest it has been since 2009.”

The next Greek government will, however, face considerable challenges. Rainer Guntermann, credit and rates strategist at Commerzbank, said: “Pension reform is perhaps the biggest issue for the next government. Its tax reforms, such as its VAT changes, have not had the desired impact.” Reversing these could be an easy win, he added.

Having spent more than eight years cutting state expenditure, there are understandably signs of austerity fatigue. As the country approaches the start of a new election cycle, politicians will be under pressure to promise an easing of cuts, and new measures to improve conditions for the poor. Some worry the resulting loss of momentum would see Greece’s economy slip back, like Sisyphus’ boulder rolling back down the hill.

On one level, Greece has made tangible progress. Like Portugal, Ireland and Cyprus before it, it is on the verge of making a clean exit from the assistance programme, with its bailout expiring in August. Greece is now running a budget surplus, meaning that, absent debt repayments, it is living within its means.

But its gigantic debt ensures a continuing sense of futility, its debt repayments fuelling an enduring need for external financing. Debt forgiveness remains off the table, at least for now, the EU holding that prospect back as leverage to ensure there is no weakening of its reforming zeal.

At least Greece does not face any large imminent repayment hurdles. With the breathing space this provides it has expressed a wish to build a cash buffer that will protect the country’s finances if its own or the global economy take a downward turn. For this, Greece needs around €9bn by autumn 2018, around a third of that having already been raised in a landmark deal in February.

The country therefore faces a dilemma: should it ask for fresh bailout loans or raise more cash in the market? It is currently undergoing a final review before making its decision.

So glad you could make it

That the market is even an option is a significant sign of progress. Investors are reluctant to discuss Greece – a testament to the political sensitivity of the subject. But the sovereign’s sub-investment-grade status means many institutions could not buy Greek paper even if they wanted to.

Despite this, Greece’s €3bn seven-year issue in February – its first capital raising in the markets since its first bailout programme – attracted €6bn of orders. Being twice subscribed, and achieving a respectable rate of 3.375%, the deal has to be seen as a success from the government’s perspective.

The trade was, however, tainted somewhat by its performance in the aftermarket. In November, Greece had swapped 20 outstanding PSI bonds worth €30bn for five vanilla benchmark bonds maturing between 2023 and 2042. The move could not completely resolve the problem of illiquidity, and when the VIX spiked the week the deal was scheduled to launch, it hit GGBs, which had been rallying since November, hard.

It was a challenging environment for any issue and its disappointing secondary market performance is therefore forgiveable. Most believe the market would be receptive should Greece choose to come back. That seems a real prospect: issuing more bonds would be symbolic of the progress Greece has made, indicating a reduced reliance on bailouts – which both the Greek government and other EU leaders are keen to see.

It would also tap into the upbeat mood prevailing across the EU. Guntermann said: “Peripheral countries are benefiting from a bout of EU-phoria. Macron has a plan for a more integrated future for Europe, and with the emergence of the new Grand Coalition, and a Social Democrat holding the finance ministry, Germany is no longer seen to be obstructing it. This makes things like a future transfer union more likely, and has definitely been positive for peripheral European spreads.”

From the EU’s perspective, a fresh Greek bond would vindicate EU policy and Germany’s insistence on maintaining pressure to push through difficult reforms. It would also ease tensions among Northern European voters, many of whom still resent financing what they see as profligate southerly neighbours.

Greece may also feel it has a limited window of opportunity. ECB QE looks likely to conclude by the end of the year, with tapering starting in Q4. Few expect aggressive rate hikes but experience suggests any hint of policy tightening will create market volatility. Challenging issuers such as Greece may not have such favourable terms after Q3 this year.

The hope must be Greece can re-establish trust and rapport with its investors. Ratings have been steadily improving, with Moodys expected to raise its rating by one or two notches at the end of March. If Greece can keep making gradual progress, and eventually secure an investment-grade rating, it could be a watershed moment: increased demand from index-tracking funds would push down the cost of borrowing – in the absence of more general market volatility, at least.

Looking at it from a debt sustainability perspective, however, the case for bond issuance is harder to make. The yield on its assistance programme loans is only 2% – below the 2.5% countries like Spain can achieve in the market, let alone the 3.375% charged in Greece’s recent deal. Bailout loans have also extended the average tenor for Greek debt to 20–30 years, far longer than many of its peers, such as the six to seven years of Spain’s public debt.

The profile of Greece’s investor base also leaves it exposed if market conditions deteriorate, as they likely will once ECB tapering begins. Nearly a third of Greece’s latest issue was taken up by hedge funds – fractionally above the 20%–30% range that is typical for a sovereign with its ratings. This is likely to exacerbate volatility for GGBs as fair-weather investors exit positions once rates start rising.

So, while the EU would be happy to see Greece back in the market, institutions such as the ECB and the IMF may take a different view. The ECB is particularly interested in the impact on Greek banks, said Sokos.

“If Greece ends its programme without an ESM credit line, then given that in all likelihood it will still be sub-investment-grade, it will lose the waiver that allows Greek banks to use Greek bonds as eligible collateral at the ECB,” he said.

“This could increase the funding cost of Greek banks, as they would have to replace ECB funding with ELA or other more expensive options,” Sokos added. “The IMF also cares about Greece’s debt sustainability and if it had to choose what is best for Greece, issuing at three to 10-year maturities in the market at 3%–4% or via the ESM at 1%–1.5% for 30 years, it would probably choose the latter.”

With that in mind, new loans are a real possibility. Castillo said: “At 3.4%, the cost of debt is too high for Greece and I doubt it can return to the market at this level. It needs to raise around €15bn–€20bn per year – around €5bn–€10bn of that in long-term bonds – and it is hard to see it achieving that at this stage. More likely, it will need more help from European creditors, which means it needs to keep pushing through reforms.”

At least Greece has the advantage of being relatively flexible on timing, meaning it can afford to wait for market conditions to be more favourable than they were in February before bringing a new deal to market. If such windows present themselves, there is a good chance it could make one or even two more visits to the market in coming months.

Sokis said: “The first deal is always the hardest. It will be very tough to bring all its old investors back on board and it was never likely to manage it with its first deal. But once it has built up its liquidity buffer even further and fully funded itself for 18 months, it will be easier for institutional investors to allocate despite their ratings restrictions.”

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Back in the market