Goldman: "Greece Post PSI"

That Goldman would have "thoughts" on the Greek PSI deal and European life in the aftermath, is no surprise: just be sure to take these with a pound of salt. After all Goldman is a key member of the ISDA's European Determination Committee (and co-chairman with JPM of our very own Treasury Borrowings Advisory Committee). Not to mention that Goldman is the firm that allowed the Greek default to happen in the first place, by allowing it to hide its unprecedented debt accumulation far beyond what was allowed by the Maastricht treaty. In either case, here is a summary of what Goldman sees happening next: "After the finalization of the PSI process, only small residual transactional uncertainty remains. The new Greece package ensures low funding costs that under certain assumptions could even be sustainable in the long term. Moreover, the exposure of the Greek private sector to the Greek government declines very substantially… …while the exposure of the European official sector rises to substantial levels. Late-April elections will be a risk; but polls suggest a pro-EUR government is the most likely outcome. The new government will be tasked with creating a better growth environment. Using our GES score, we observe key areas of structural improvement for Greece’s growth environment… …among others, the creation of a more business friendly environment, the establishment of conditions for increased openness to trade and a more effective rule of law." We will shortly present a far more realistic, and far less conflicted.

From Goldman Sachs: Greece Post PSI

1. PSI Process Finalized At A High Participation Rate

Early this morning the Hellenic Republic issued an announcement on the successful outcome of the exchange offer under the provisions of the plan for Private Sector Involvement (PSI) in the second Greece support package. EUR172bn-worth of bonds issued under Greek law have tendered their holdings of Greek government debt. Of these, EUR152bn (or 86% of the outstanding face amount under current offer) consented, while 5.3% opposed the amendments.

The Republic has also received tenders for exchange and consents for 69% of bonds issued under foreign law. The deadline for foreign law bonds has been extended to March 23, with a settlement date of April 11. Accounting for the 69% participation in foreign law bonds, the overall exchange participation could rise above 95%.

As per the official release, the Hellenic Republic has advised its official sector creditors (which will contribute ‘sweeteners’) of its intentions to accept the consents received and amend the terms of all its Greek law governed bonds, including those not tendered for exchange pursuant to the invitation, in accordance with the relevant legislation. Subject to Eurogroup approval, Collective Action Clauses (CACs) are thus likely to be invoked. The ISDA EMEA Determinations Committee will meet at 1PM GMT today to discuss this, and to determine whether a credit event has occurred. If CACs are invoked, this is almost certain to be the case.

US payrolls will be the key focus of the day; we expect non-farm payroll employment to have increased by 200k jobs vs 243k jobs in January. We expect the unemployment rate to fall to 8.2% (down 0.1% in February).

2. Residual Transactional Uncertainty

Following the finalization of the PSI exchange offer, the Eurogroup will convene to decide on the next steps with respect to the new Greece financing deal. Two areas of residual transactional uncertainty remain:

  1. The outcome of the upcoming international bonds exchange. As opposed to local law bonds, Collective Action in foreign law bonds is assessed on a bond by bond basis. Although the 69% participation in the foreign law bond exchange implies that CACs will likely be triggered in the majority of debt under foreign law, there is still the chance that, in some issues, the necessary participation is below the necessary threshold. International law bonds may represent only a small part of the total debt stock eligible for PSI, but the lack of excess funds in the new Greek support program leaves little room for significant private-sector debt payouts. How the small amount of potential holdouts (about EUR8bn according to the participation quota published) will be treated will attract some market attention.
  2. What will the CDS triggering process look like? Invoking CACs would most likely lead to a CDS trigger. Although the net exposure of the market to CDS contracts is reasonably small, there are still small pockets of uncertainty in the process, mostly linked to the type of securities that will be delivered for the CDS to pay out and the distributional aspect of gains and losses.

All told, however, the remaining areas of residual transactional uncertainty are probably of secondary importance in comparison to the broad market relief stemming from the avoidance of a disorderly near-term credit event.

3. Post PSI Greece: A Significant Reduction in Funding Costs & A Shift in the Skew Of Risks

As Francesco Garzarelli has recently discussed, the reduction of funding costs from the PSI are substantial; for the next decade, the new GGBs will carry a coupon of about 2.6%. Official funds will carry interest of 150bp over Euribor. Overall, despite a still high projected debt stock of about 120% of GDP by 2020, coupon payments are projected to hover close to 3% of GDP, below the pre-crisis average coupon stream of about 4.5% of GDP.

A coupon payment flow close to 3% of GDP suggests that Greece can see its debt stock declining slowly over time under very moderate assumptions of 1% trend growth, 2% (Eurozone-like) long-term inflation and a small primary surplus of about 1% of GDP. Debt sustainability is far from guaranteed but the hurdle is much lower.

Moreover, the migration of risk in terms of Greek government debt ownership creates a significant shift in the balance of risks across sectors. The exposure of the Greek private sector to the Greek government declines to EUR26bn (after a 50% notional write-down and a 15% PSI cash payout), the market value of which is about EUR8-9bn; overall a very small exposure wherever mark-to-market applies.

In contrast, the exposure of the European official sector to Greece risk increases; adding together the two rescue packages and the liquidity with which the ECB has supported Greek banks, total lending from the Euro-area official sector to the Greek government and banking sector rises to about EUR350bn.

4. A Shift in The Balance of Local Politics; Exchange Rate Flexibility Will Remain Undesirable

At the end of the legislative process that accompanies the second Greek bailout package, the current government will call for elections sometime in late April/early May. In the background, the Greek political scene is undergoing a significant transformation.

The traditional split between centre-left and centre-right is no longer the key dilemma for Greek voters. The unconditional support that the two major centre parties have shown to the coalition government under PM Papademos has created a fresh split, with those political groups willing to bear the necessary costs and keep Greece within the EUR competing against those who are either anti-EUR or at best ambiguously positioned on the subject.
Polls continue to point to significant support among the Greek public for Greece’s presence in the EUR as a means to safeguard political and systemic stability. From an economic perspective, as we have shown in a recent Global Economics Weekly, it is far from clear that FX flexibility would help Greece adjust its external imbalance unless it was able to withstand a very large real exchange rate shift.

5. The Ultimate Challenge: To Foster A Better Growth Environment

The key task of the next government is to create conditions for sustainable growth in the absence of monetary and fiscal policy flexibility. Structural reforms will be the key vehicle.

There is a lot of room for Greece to make structural improvements on the supply side. Relative to other developed economies, Greece ranks very low according to our 2010 Growth Environment Scores. From a sample of 183 countries, Greece ranks in the low 70s, close to emerging economies such as Thailand and Brazil. Furthermore, its relative position has deteriorated since 2004.

Drilling deeper into the different components of our indicator, Greece ranks high in infrastructure scores, education and life expectancy (public health). However, an unfriendly environment for investment, a low degree of openness and a low ranking in the rule of law categories constitute the key factors limiting Greece’s growth potential and are thus in need of significant improvement.