Greece plans to issue a new benchmark five-year bond. We believe that changes in the European political landscape, together with recent strong economic data, mean the bond should perform well.
When deciding whether to invest in Greece, or any other European country that has found itself in difficulty amid the debt crisis, investors are ultimately making a call on European politics. Arguably, the market priced in too much European political risk premia at the start of the year.
Today, European solidarity appears higher than it has been at any time since the Brexit vote (indeed, to some degree, Brexit has united European politicians). This is helped enormously by the positive-growth environment seen in most European countries. Political discontent tends to fade as unemployment drops and wages improve.
Emmanuel Macron won the French presidential election earlier this year on an unashamedly ‘more Europe’ platform and has breathed more life into the European project. At the same time, German Chancellor Angela Merkel will not want a resurgence of the Greek crisis so close to her general election.
On the Greek side, the ruling SYRIZA party has found itself far behind centre-right New Democracy in the polls. Anger and protest are no longer translating into votes, so SYRIZA is now hoping for a quick resolution to the debt-relief negotiations and an upswing in growth before general elections, scheduled for late 2019. A snap election now is not in its interest.
There are signs that the growth outlook is turning a corner and broadening. Tourism is booming, while year-on-year industrial production is growing at a rate of over 5%. Even more encouraging is that unemployment is dropping, raising aggregate real incomes, and as a result the Greek consumer is becoming more confident – retail sales are up 4.6%, year-on-year. Lastly, the scale of austerity that the Greek government needs to undertake has fallen, adding a further tailwind to growth. So Greece’s growth revival can continue, in our view.
The main risk lies with a disagreement between the International Monetary Fund (IMF) and Greece’s European creditors about the nature of debt relief for the Aegean state. This may not be a smooth path: Germany is insisting on IMF involvement; the IMF insists on debt relief; and the German government doesn’t want to bring a debt-relief proposal to the Bundestag before the election (as it would be required to do).
Whether Greece has a debt-GDP ratio of 100% or 200% today makes little difference to economic performance in the next two-three years. What matters is that supply-side reforms continue, encouraging investment, and that debt-service costs are low (currently Greece’s debt-service costs are lower than those of Italy or Portugal). We believe, therefore, that Europe and the IMF will not push Greece into default over this disagreement.
Imposing further haircuts, or losses for investors, on Greek government bonds (GGBs) would be an expensive option to take for a few reasons:
- GGBs form a very small part of Greece’s overall debt now, with most debt in the form of official loans
- Despite the low risk of ‘contagion,’ haircutting Greece’s bonds would increase the premium paid by other low-rated European sovereigns. The precedent would also not serve Europe well should a country enter a severe downturn before any serious form of fiscal union is in place
- Greece could lose market access again, leaving European creditors either to ask their electorates for more cash or push Greece outside of the Eurozone
It is possible that Greece could find itself in a virtuous circle, where it becomes eligible for the European Central Bank’s (ECB) asset-purchase programme – for this to happen, Greece would need to pass the monetary guardian’s debt-sustainability analysis. France has proposed linking debt relief to economic growth, a measure that would give the ECB more confidence when conducting its analysis.
Net net: Greece’s prime minister, Alexis Tsipras, left behind ‘collision economics’ a long time ago, and has apparently decided that the best strategy for re-election in 2019 is to exit the bailout programme. For this, he needs economic growth, access to markets and cooperation with European partners. A successful Greek exit from the aid programme would also be a boon to European policymakers, who have long faced criticism about their approach to the Greek crisis and don’t want to ask their taxpayers for more cash when this bailout package expires next summer. In this environment, it seems to be in everyone’s interest for this bond sale to go well.