Goldman's Take On The Greek Bailout: The Lawsuits Are A-coming

From Erik Nielsen

Europe this week

A few more details have come out on the Greek bail-out since I circulated my Sunday email this afternoon, specifically with respect to the potential size of the package.

Specifically, the Euro-zone finance ministers agreed this afternoon to make available – if requested by Greece – EUR30bn to be disbursed during the first 12 months, and (apparently) with a 3-year maturity, at an interest rate of either 3-month EURIBOR rates or a fixed-rate based upon the rates corresponding to Euribor swap rates for the relevant maturities.  Either way there’ll be a 300bp charge on top of the base rate (and a further 100bp for loans longer than 3 years, if that were to be the case), as well as a one-time service charge of max 50bp.   As agreed earlier, the all Euro-zone governments will participate in a ratio equivalent to their capital share in the ECB.  The ministers also said that they envisage a 3-year IMF program worth 10-12 times quota, which would be about EUR12-14bn extra.  There was no comment on the potential mis-match between 3-year money from the IMF and 12-months money from the European partners, but an unidentified senior finance ministry official said that "a logical amount for the three-year period would be significantly higher than EUR 40 billion, but this has not yet been determined."

In my view, this is good news because the amount of money is more than I had expected (although for only a 12 months period), although the program would still not be fully funded (but close.)  Even if it were to be a full EUR45bn for the first 12 months, this would cover “only” about 2/3 -3/4 of their needs during this period.  The interest rate is about the 5% I mentioned in my email earlier.  The issue of whether this is concessional or not will be debated for a long time.  My view is clear:  Sure it is concessional, so we’ll probably see some interesting court cases if the loan gets disbursed.

Beyond the size, I am not particularly surprised.  As we have been arguing for months, Greece would not be allowed to default in April-May, so money would be made available, if needed.  But as discussed before, there always were two key issues to get comfortable with: (1) the issue of actual disbursement (could we be sure it would come in time?), and (2) what about the longer term sustainability issue?

What today has brought is further clarity on the long-held assumption that Greece would indeed be bailed out, if necessary, because of today’s political commitment which is more detailed than before (as one would expect as we move closer to the deadline).
However, what today has NOT provided is clarity on disbursement.  Both the EUR30bn in bilateral money would have to be approved in the legislatures in each of the Euro-zone’s member states before it could be disbursed (and its not clear how long time this would take), and the IMF component would have to be negotiated with IMF staff (presumably to begin in more detail this coming week), and then approved by the IMF Board (the latter a formality), before it could be disbursed.  I presume that both could happen within days if really needed, but under normal circumstances these things would take at least 2-3 weeks.  Which bring us to the end of the month; our long held target date for an IMF/EU program.  Also, I am not sure how the officials will deal with the issue of medium term sustainability.  Even at an average rate for official money of about 4%, Greece would have to generated a 5-6 percentage point turn-around in the primary fiscal account, and then keep it there, while generating about 1% real GDP growth per year and a current account surplus to generate the transfer of interest payments to foreign creditors.

My bottom line: Good to see the additional details, and in particularly the larger amount, which further confirms that the Europeans will not allow a default this year.  I remain a tad worried about the process of making the money available in time as well as (very) concerned about the issue of longer term sustainability.

While activation (when legally ready) would have to be called by Greece, we continue to think that such official money will indeed be needed to get them through May.

Erik F. Nielsen

Chief European Economist

Goldman Sachs

And here is what Erik sees as the key events in Europe this week:

I am pleased to announce that spring has arrived in Chiswick! – come see the magnolias and cherry trees here in my neighbourhood; magnificent!  Unfortunately, I haven’t had much time to enjoy it so far because it has been another crazy week in Europe.  Here’s a summary of how I see it all:

    *More good news on the overall European growth front, although part of Southern Europe continues to struggle; we’ll be revising our GDP numbers on Thursday showing stronger overall growth but still greater divergence within.
    *Meanwhile, Euro-zone policymakers have been scrambling to respond to last week’s acceleration in the Greek crisis.  Greece has asked for the details of the offered bail-out (but not for it to be activated); the Eurogroup and Commission met this afternoon and delivered another dose of mostly unspecified support statements, other parts are likely to be negotiated with the IMF (and the Commission) this coming week.  I continue to expect an “activated” program to be agreed before the end of the month, but I still doubt that it’ll put the Greek debt sustainability issue to bed.
    *The ECB back-pedalled last Thursday and decided not to introduce a sliding scale for sovereign haircuts after all.  Apart from the substance, it was one of the most unfortunate press conference I have seen in a very long time.
    *Poland’s president, central bank governor and many others were killed in an airplane accident yesterday.  While tragic, we do not think this ought to cause any concern for Polish assets.  The accident happened the day after Poland for the first time intervened to weaken the zloty.
    *Hungary looks set to vote into power today a new centre-right government which we think will lead to important reforms and a revival of the economy; HUF bullish.
    *Looking into next week, Greece will remain in the spotlight with more European meetings and important auctions in Athens.
    *The Euro-zone will publish reasonable important IP and inflation numbers this week.
    *The main event in the UK this coming week will be Thursday’s TV debate between the three political leaders; a first of its kind in the UK and potentially very important for the outcome of the election.
    *Switzerland and Sweden both publish important inflation data this coming week.
    *Turkey’s MPC meets on Tuesday; we think it’ll mark an important turning point in CBRT’s policy stance.
    *Finally, Iceland is schedule to get the IMF’s stamp of approval (and money) on Friday.  Hurrah!

 -1            Last week delivered further evidence that the overall European recovery is well under way.  The final March PMI for the Euro-zone – the single best indicator for final GDP - was better than the already strong flash number.  Meanwhile, industrial production disappointed a bit, but I am pretty sure that that was mostly weather related (meaning that it’ll bounce back in a month.)  Part of Southern Europe is still struggling, of course, (Greek IP was down 9.2% in February), but its all part of our overall 2010 European theme of divergence, and Greece is not big enough to stem the overall European recovery.  All in all, our 2010 GDP forecasts throughout Europe (with the exception of a couple of the smaller Euro-zone countries) look too low, so we are in the process of re-working the numbers; look out for the European Weekly Analyst on Thursday which will have the details.

-2            European policymakers have scrambled this past week to come up with appropriate measures in response to the Greek crisis which began to accelerate at a frightening pace.  First, remaining investors began to throw in the towel, sending spreads wider early in the week.  Then it was reported that the domestic sector might be losing faith, causing drainage of deposits from the banking system.  Thursday night, Greek PM Papandreou called the EU presidency to request that the offer of a package get specified with respect to the terms and conditionality, which was then followed by a full-day Greek cabinet meeting Friday to discuss the government’s exact stance ahead of any negotiations.  Finance minister Papaconstantinou emphasized late on Friday that “Greece does not intend to make use of the mechanism but it is very important for our country for this safety net to exist.”  Papandreou added yesterday that “the question remains whether this mechanism will convince markets just as a gun on the table.  If it does not convince them, it is a mechanism that is there to be used … the euro is not to blame for our problems. Greece belongs in the euro-zone. Any other scenario is ridiculous."  The Eurogroup and Commission met this afternoon (by telephone) and delivered another dose of mostly unspecified support statements, although Commissioner Rehn said that the Europeans will charge about 5% in interest rate for a 3-year loan, although Juncker said that the combined program (EU plus IMF) could be about EUR30bn for the next 12 months.   I am pleased for the Greeks if the 5% gets confirmed, but I not sure how anyone can call such a rate “non-concessional”, as the EU Summit’s press release said it would be.  To put it very simple, while Euro-zone citizens presently charge more than 7% for loans to Greece (when using their savings via pension funds and bank deposits), their governments will ask for “only” 5% for loans to that same debtor when using those same citizens’ tax money.  I wouldn’t be one bit surprised if some of Europe’s courts will end up having to decide on the definition of concessional vs non-concessional.

-3            Anyway, the exact interest rate charged on the bail-out package is a bit of a red herring, because the real issue will be whether Greece can re-generate growth while cutting the fiscal deficit because without growth, the debt is only sustainable if someone will finance them at much less than 5% (or the IMF;s 3.25% for that matter) for the next decade or more.  And to generate growth, competitiveness has to be restored, and for that to happen, nominal wages will need to decline substantially, maybe by as much as 15%-20% (unless we get some sort of productivity miracle.)  Is this do-able? I suspect that the IMF’s heavyweights will be heading to Athens now to start discussions with the government on precisely this issue.  The good news is that from maybe already tomorrow, we have enough of an agreement so that Papandreou can fire his gun, if needed (but just like Hank Paulson’s bazooka needed to get out of his pocket, I continue to think that Papandreou’s gun will need to be fired before the end of the month.)  However, EUR30bn will not fully cover the Greek government’s financing needs for the next 12 months, let alone for 3 years, so Greece will still rely on commercial money beyond the April-May payments, and whether such money will become available will very depend on how credible the policy framework is and what investors think will happen beyond the program period.  Unfortunately, this thing is unlikely to go to bed any time soon.

-4            In the same vein of scrambling in response to the acceleration of the Greek crisis, the ECB seemed to back-pedal on Thursday.  Hence the ECB press conference, which was supposed to provide the details of Trichet’s pre-announced changes to the collateral system - which he had said two weeks earlier would include a higher threshold for losing eligibility as well as a sliding scale of haircut - turned out to deliver only the former.  As I argued after Trichet’s pre-announcement two weeks ago, what he seemed to suggest could be very bad for Greece, and I suspect that they ended up back-pedalling out of concern that they might otherwise trigger a collapse in Greece.  At least, I think that they decided not to introduce the sliding scale for haircuts for sovereigns.  Not that Trichet said so, but I concluded so after having re-read umpteen times this part of the press releases: “No changes will be made to the current haircut schedule foreseen for central government debt instruments and possible debt instruments issued by central banks that are rated in the above-mentioned range”.  I think that’s what it means, but I am not 100% sure, and the ECB has so far declined clarifications.  Bizarrely, while moving the threshold, they are keeping the cliff over which they threaten to throw the sovereign securities, which- of course - is entirely unconvincing; just wait and see if we get sufficient downgrades to threaten that new threshold, then we’ll have another change, possibly followed by the same peculiar insistence that it has nothing to do with Greece.  Well, we got the first step in this direction the very next day when Fitch downgraded Greece by two notches to BBB– with negative outlook.  We shall see.

-5            Saturday morning a plane carrying the Polish president, central bank governor and more than 80 other people, including a large part of the senior Polish military establishment, crashed in Russia killing everyone on board.  As Magdalena Polan explained in her note shortly after the accident, Poland's governing structures are clear and undisputed, and the policies of the personalities now taking over these key positions are well known, so – in our view - there is no fundamental reason for adding any risk premia to Polish asset on the back of this tragic accident when markets open on Monday. That said, we'll continue to monitor events very closely.  The accident came less than 24 hours after the Polish central bank, clearly fed up with months of zloty appreciation (some 6% since New Year), intervened by selling zloty against euro, pushing the FX 1% weaker.  This was the first Polish intervention since they introduced convertibility and hence a potentially very important signal for their priorities and tools going forward.  However, unilateral interventions are rarely effective longer term, so we have decided to keep our Polish FX forecast.  But the overall message is dovish, so while we also have kept our forecast of 50bp rate hikes by year-end, we now see clear downside risk to this forecast, as discussed in Friday’s note by Magda.

-6            Hungary is holding parliamentary elections today, and it looks as if the centre-right Fidesz will win an overwhelming major.  Polls close at 6pm London time, and the first results should come through a couple of hours later.  Fidesz has campaigned on a platform of fiscal consolidation (with tax cuts!) and structural reforms.  We think a Fidesz government will agree to a new IMF-backed stabilization program later this year (but probably with loser conditionality) and that this will help tip Hungary into a “positive equilibrium”, reducing the overall risk premium on Hungarian assets, facilitate capital inflows and support economic recovery.  As Magda Polan discussed in last week’s New Markets Analyst, we expect that this will result in some HUF appreciation, which will in turn help keep inflation pressures in check.  The NBH should respond by easing monetary policy further to support the recovery process.

Looking into this coming week:

-7            Greece will remain in the news, of course.  The Eurogroup and the Commission will meet again tomorrow Monday.  Then the attention moves to Athens where we’ll get an first indication of their funding power on Tuesday as Papandreou’s gun gets loaded.  The government holds a 6-months and a 12-months auction for EUR600 million a piece.  They are facing maturing T-bills and other debt related payments on Tuesday of EUR985mn and on Friday of EUR1.3bn before some EUR10bn comes due the week after next (on the 20th and 23rd).  Assuming that Tuesday’s auctions go okay there’ll be another auctions for 3-months money on the 20th.  Also, it’ll be worthwhile watching any news out of the IMF (or government) if negotiations get under way.  And finally, on Friday, there’ll be a long scheduled  informal Ecofin meeting on Friday in Madrid.  The program will begin at 9:00am with a meeting of the Eurogroup ministers, followed by a press conference at 12:30.  At 15:30 the first session of the ECOFIN informal meeting begins.

-8            Two important data set coming out of the Euro-zone this coming week: First, on Wednesday we’ll get Euro-zone industrial production numbers for February (EMEA-MAP relevance score of 5), which obviously serves as a key input into our GDP projections.  Judging from the country figures already reported from Germany, Spain and France (which came in a bit weaker-than-expected), and assuming Italy comes in line with our expectations tomorrow Monday (+0.2%mom), the Euro-zone aggregate should be roughly flat on the month. T his is slower than the pace suggested by our (so far very reliable) leading indicator of IP, but would still generate an IP gain of 1.5-2.0% qoq, which bodes well for Q1 GDP.  The Euro-zone has recently suffered from some of the same divergence between survey numbers and IP numbers, as in the UK, and as in the UK we think the surveys will turn out to be more accurate than the first prints of hard numbers.  Second, on Friday, we’ll get the full inflation report for March.  The flash estimate of the headline rate already surprised to the upside, rising from +0.9%yoy +1.5%. While we doubt that core inflation was behind the spike, the full component breakdown should shed some light on which components were the principal drivers.  This could become very important as we are heading through the ECB’s gradual exit strategy.  Unrelated, the ECB releases its latest Monthly Bulletin on Thursday.

-9            The main event this coming week in the UK will be the party leaders’ TV debate on Thursday night; the first of its kind in any UK election campaign.  I suspect that it may have some bearing on the election result.  Watch for poll reactions that evening and the following day.  The week will be thin on data releases, and both releases of some intersst will be on Tuesday morning.  First, we’ll get the results of the March RICS and BRC surveys.  The consensus expectation is for a very small decline in the first (like-for-like sales growth from 2.2% to 2.0%), a very small rise in the second (a price balance of +18 from +17 in February).   Second, we’ll get March trade data.  Consistent with strengthening surveys and with the bounce in manufacturing output in February we expect the aggregate goods and services deficit to fall from £3.7bn to £3.0bn, close to consensus (£3.1bn).

-10          The only important releases in Switzerland this coming week are producer and import prices for March (on Friday).  After firming from -1.3% to -1.0%yoy in February, we expect a continuation of this upward trend to come through, reflecting the continued influence of base effects rather than any substantial inflationary pressure at the producer level.

-11          It’s also inflation week in Sweden in the shape of consumer prices for March on Tuesday.  We expect an unchanged 2.7% for the more important CPIF (CPI excluding the direct effects of interest-rate changes, but including the effects of changes in house prices, energy and food).  The Riksbank pencilled in a 2.3%yoy, but they have been too low for several months in a row.  Further out, we are in line with the central bank and expect a sequential easing in CPIF inflation to come through in Q2 and Q3 as the base effect from last year's fall in oil prices fades and the output gap keeps underlying inflation contained.

-12          The Turkish MPC meets on Tuesday for its regular rates decision (unchanged at 6.5% but an official end to the dovish bias), followed by Governor Yilmaz’ long overdue outline of their exit strategy on Wednesday.  We expect Yilmaz to announce a series of measures that will result in gradual tightening of domestic monetary conditions.  We don’t expect the much detail on the rates trajectory at this stage, but we believe this will become clearer once the CBRT releases its quarterly inflation report on April 29.  Overall, as Ahmet Akarli has discussed, this coming week will mark an important turning point in CBRT’s policy stance – a shift away from its persistently dovish stance as they start preparing the market for a steady tightening in monetary conditions.  We continue to see a cumulative 250bps rate hike in 2010H2, and another 100bps in 2011.

-13          Finally, Iceland is getting a break.  Following an IMF statement just before the weekend that agreement has been reached on a Letter of Intent for the second review under their Stand-By arrangement, the IMF Board is now scheduled to consider it on Friday.  The FT quotes “Icelandic officials” as saying that the UK and the Netherlands have indicated that they are now prepared to support resumption of lending even without an agreement on Icesafe.  If so, Iceland will be able to draw its third tranche from the IMF, worth about $160 million, at the end of this coming week.  This is a welcome break-through in this long and bitter intra-European stand-off.

And that’s the way it all looks from sunny Chiswick on this beautiful Sunday.