Goldman's Francesco Garzarelli adds fuel to the speculative PIIG fire:
Below are some reflections published yesterday evening on the unfolding events in Greece and Portugal. The thoughts on Greece add to what I wrote on 21 April (‘What to Make of the Greek Debt Restructuring Talk’). My thoughts on Portugal benefit from several discussions with the private and official sector in Lisbon last Wednesday and Thursday.
- We are broadly sticking to the investment strategy we laid out in January-March: a segmentation of EMU sovereign risk between the three ‘program countries’ and an ‘EMU kernel’ comprising the current AAAs and Italy/Spain/Belgium. The ESFS bonds –built on a pro-rata credit risk basis – are a reasonable (albeit credit-enhanced) expression of this ‘kernel’ risk. Total issuance by the EFSF will amount to EUR50-60bn over the next 3 yrs.
- Regarding Greece: We do not see a ‘haircut’ as a viable solution, particularly at this juncture, for a number of reasons: 1. The risk of potential financial ramifications (‘domino effects’) seem too large; 2. the level of debt that is sustainable will be guesswork until growth has stabilized and a primary surplus achieved; 3. the incentives for pursuing adjustment (in Greece and elsewhere) may wane if the debt stock is aggressively reduced; 4. finally, private-sector funding is unlikely to flow back at sustainable levels any earlier than under the current approach of conditional financial support.
- We continue to believe that a more viable solution would be to prolong the period over which Greece delivers its necessary adjustment, which would help the government to deliver. This would mean providing more funds to the sovereign to make up for redemptions, at least over 2012-13, and recapitalizing the local banks. The choice between involving the Euro-zone private financial sector through debt extensions, in order to divert funds from the existing program, or ‘topping up’ the existing conditional funding (and concomitantly forcing the Euro-zone financial sector to set aside more capital for sovereign risk in the event of future impairments), is ultimately a political one.
- We still do not expect to see sovereign liability management exercises in Ireland and Portugal. Bonds in these two sovereigns will, however, likely remain subject to higher volatility, reflecting decisions taken on Greece in coming weeks, in addition to local events (e.g., the Portuguese elections, approval of the support package, etc.).
- Over the next few years, it is likely that program countries will have between 40% and 50% of government liabilities held by the official sector. These securities could eventually be subordinated, or carry more favorable conditions than those available at the time in the private markets. This could represent a step towards the evolution of a ‘common bond’, with additional funding at the country level.
- For background, below is a chart on the Greek debt profile; see also this paper by our banks team, which discusses the extent of bank losses in the event of a ‘haircuts’ in the program countries (these take into account tax shields).