Finally, A Rescue Plan To Save Greece: But, Will It Work?

Over the weekend, the details of a plan to bail out Greece were finalized.

Euro-Zone members have promised to provide up to €30 bilion ($40.5 billion) in loans to Greece over the next year to ward off an oncoming debt crisis that has de-stabilized financial markets and posed the most serious challenge to the Euro in its history.

Those funds were agreed to during an emergency teleconference of Euro-Zone finance ministers on Sunday and would be supplemented by contributions from the International Monetary Fund (IMF) that could produce an additional €15 billion ($20.2 billion).

The rates charged to Athens would be around 5%  for a 3-year fixed loan – above the IMF’s standard lending rate but below those currently demanded by institutional investors.  Two-year Greek bonds were  trading at 7.45% last week.

One of the most contentious issues was interest rates, with Germany insisting that Greece pay “market rates” while France and other Euro-Zone members pushed for subsidized rates.

News of the rescue plan gave Greek debt and Credit Default Swaps (CDS) a significant bounce.

The cost of insuring Greek sovereign debt against default dropped sharply in early trading Monday, with 5-year sovereign CDS trading at around 3.64%, down sharply from a closing level of 4.26% Friday.  That is the equivalent of a drop of €62,000 in the annual cost of insuring €10 million of Greek government debt for 5 years.  Greece's 5-year CDS hit 4.70% at their highest last week . They are now at their tightest levels since March 5.

In cash bonds, the brighter market mood was most evident in short-term debt, demonstrating that investors see a much lower risk of an imminent Greek debt default.  Greece's 1-year CDS dropped to 4.62%  Monday morning, from 6.50% Friday, while 3-year CDS fell to 3.97% from 5.14%.

Despite the relief emmanating from the new plan, a significant hurdle comes later in the month, when Greek government officials will fly to the U.S. around April 20 to test investor interest in a planned dollar-denominated bond issue of $10 billion.  The debt placement is deemed important to help fill Greek funding gaps through the end of May.

The compromise on the interest rates charged Greece has raised questions.  A 5% rate for a 3-year fixed-rate loan represents a concession relative to last week's market levels.  But, this is still 3.7% over 3-year German debt — a long way north of where the Greeks would like to be able to borrow.  If Greece were to take a 10-year loan under the package, it would be at a rate of more than 7%, a yield Athens deems extreme.

This may act as a floor to private-market rates.  Institutional investors may wonder why they should receive less than Greece's fellow Euro-Zone members.

Now that the immediate funding issue has given Athens a sigh of relief, the key will be whether Greece can reign in its budget deficit, which last year ran at 13% of GDP.  Given the high level of debt and the accompanying high levels of interest rate on that debt, this may prove to be a tall order without draconian budget cuts.

Marko's Take

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