On Wednesday, the yield on Greece’s 10-year benchmark bond jumped to its highest level in a over a decade, Greek stocks fell, and the cost to insure Greek government bonds against default rose again. An International Monetary Fund team visited Greece, reflecting concern over a mammoth national debt—113% of annual output—that governments in Athens have spent years accumulating and sometimes masking.
Situation’s gotten worse today:
When Greece emerged from a European Union summit two weeks ago with the blueprint for a joint euro-zone and International Monetary Fund package tucked in its back pocket, many hoped the plan would stay exactly that: a plan. But soaring yields and fear of contagion to the banking sector have raised the chances Greece will have to call for concrete aid.
The presence of the aid package might have been expected to calm markets; but continued opacity over its workings and fears that political disagreement could prevent swift disbursement have left investors with more questions than answers. Greek 10-year bond yields hit 7.49% Thursday, a level not seen since 1998, sending the country back to pre-euro era borrowing costs. More worrisome, the real damage is at the short end of the curve and in the volatility of prices: Two-year Greek bond yields have risen more than two percentage points in just two days to 7.68%, a shocking 6.75 percentage points above German debt.
Adding to investor nerves, Greek bank deposits by domestic residents have declined sharply. As J.P. Morgan notes, though, it is difficult to know how to interpret this. It may perversely say more about the Greek government’s success in tightening fiscal policy, leading to worries about tax increases, than about lack of confidence in the banks, which have so far weathered the financial crisis well.
The result is that Greece may now have a case for proving that “market financing is insufficient”— the condition laid out by euro-zone leaders for providing support—as it seeks to raise €11 billion ($14.7 billion) to cover May’s refinancing needs. Finance Minister George Papaconstantinou says the country will keep on borrowing and seek to restore credibility. But plans to issue a dollar bond have gotten a cool reception by the market, and investors will be looking with trepidation at the performance of the new bonds sold by Greece this year: Last week’s seven-year issue has fallen six points already.
What might a rescue package look like? Greece might be able to borrow €15 to €20 billion from the IMF, with perhaps €20 to €25 billion coming from the euro zone, Barclays Capital estimates; this would certainly cover funding needs for the rest of the year. The IMF funding at least would be cheaper than market rate, at 1.25% for the first €3 billion and 3.25% for the rest; the euro zone might settle somewhere between 5% and 6% to reflect recent bond issue costs.
Tensions will remain high. Mr. Papaconstantinou is right to focus on continuing to implement Greece’s planned fiscal tightening. But the market now seems unwilling to give Greece the time it needs to repair its damaged credibility.
Also watch this video analysis from FT on whether the Greek debt crisis could be contagious.