Last Tuesday, Greek Prime Minister Antonis Samaras proclaimed a 'new day' in Greece after European finance ministers cobbled together a new plan involving the postponement of interest payments for ten years, the extension of debt repayment deadlines, and a controversial debt buy back plan. Additionally, the ECB agreed to pass its SMP profits on Greek debt to eurozone governments who will in turn pass the money to Greece (the intermediary countries allow the ECB to escape charges of monetary financing on a technicality). For its part, the IMF finally gave in and raised its target for Greece's 2020 debt-to-GDP ratio to 124% from 120%.
The IMF has insisted that it will not approve the next disbursement of aid to Greece until the country buys back some 30 billion euros in debt from private creditors, a move which reportedly will cut Athens' debt load by around 20 billion euros and slash 11 percentage points off its debt-to-GDP ratio. The buyback must be completed by December 13 to clear the way for the next tranche of aid and Greece will need to borrow some 10 billion euros in order to complete the buyback.
Here's where the situation gets tragically comical. Greek banks hold around 17 billion in Greek bonds that Athens will be seeking to buyback. According to estimates, Greece's banks hold the debt at between 22-25 cents on the euro meaning, according to bankers quoted in the Reuters piece cited above,
"...[the banks] would...book a profit on the deal...[but] would likely forego about 3-4 billion euros in interest payments over the next 10 years if they participated."
Ironically, the banks really have no choice in the matter. Successful completion of the buyback is a precondition to the disbursement of the next installment of bailout money and as Reuters notes, because some of the participating banks are set to be recapitalized by the bailout funds, the banks are stuck between a rock and hard place. Either they participate in the deal and take a loss on the interest payments, or they refuse to participate, jeopardizing the disbursement of the bailout funds and, by extension, their own solvency. How hilariously sad.
Additionally, if the banks were to refuse to participate, not only would they put their own recapitalization funds at risk, their refusal to cooperate would also send yields on the Greek debt they hold soaring, causing the prices of the bonds themselves to fall. This is also a decidedly unpalatable scenario for the banks and will likely provide some incentive for the them to participate.
For his part, Greece's Finance Minister Yannis Stournaras believes the buyback presents private creditors with an "opportunity, at the prices involved." While Stournaras has said the program will not be mandatory, he nonetheless insists that it "must succeed", two contentions which could conceivably be construed as contradictory.
In any case, Greece will need to borrow 10 billion euros in order to complete the buyback. There are two absurdities inherent in this plan one readily apparent and one not. First, Greece is borrowing money to buy back debt, a move which is akin to paying off one credit card with another. Second, the loan is expected to come from either the EFSF or the ESM, both of which were unceremoniously downgraded Friday by Moody's and both ratings carry a negative outlook. One way to put the ratings on even shakier ground would probably be to take 10 billion euros and throw it into the Aegean, which, in essence, is what any entity which loans Greece money is doing.
All of this may not matter in the long run in terms of Greece meeting its debt-to-GDP target. There are two components to a debt-to-GDP ratio and, as ZeroHedge has pointed out recently, even if the numerator in this equation is reduced, the denominator must rise or at least not fall in order for there to be a net positive result. Unfortunately, estimates for Greek GDP have been hopelessly optimistic and have a history of downward revisions as Exotix Fixed Income reminded investors last month:
"The IMF forecast for...[Greek] 2013 nominal GDP has been reduced by an astonishing 22% in the two years since Nov 2010. In our opinion it is this unanticipated decline in economic activity that has surprised the Fund, and driven a stake through the heart of the programme. We would be interested to hear if someone else knows of a bigger or more significant 2-year forecasting revision for an industrialised economy."
The following chart shows the series of downward GDP revisions issued by the IMF since April of 2010:
Source: Exotix, IMF
Given this and given the fact that nominal GDP growth was -6.2% in 2011 and is expected to be -6.5% in 2012, it seems extraordinarily dangerous to base the disbursal of rescue funds on a series of forecasts which predict a dramatic (indeed, an 'epic') V-shaped recovery for the country. Consider for instance the following table which shows this expected miracle turnaround in GDP growth:
As you can see, beginning in 2014, the Greek economy is expected to start growing and in the 9 years that follow, the country is expected to post growth rates of around 4% or more each year. It goes without saying how ridiculous that is and lest should anyone be tempted to think that the 'experts' have any idea what they're talking about here, remember that from November 2010 to October 2012, the IMF's forecasts for 2013, 2014, and 2015 Greek GDP were revised down by 22%, 24%, and 25% respectively and the IMF's predictions for Greece's debt to GDP ratio in 2013, 2014, and 2015 were revised up (over the same period) by 37.8, 40.8, and 40.1 percentage points:
Source: Exotix, IMF
As JPMorgan's David Mackie puts it,
"The [posited] debt dynamics...still assume ambitious fiscal numbers for Greece and solid nominal GDP growth. Greece is assumed to be able to run a primary surplus of 4.5% of GDP on an indefinite basis, and nominal GDP growth is assumed to average over 4%."
Zsolt Darvas, a fellow at Bruegel, noted recently in an interview with the NY Times, that meeting the IMF's 124% debt-to-GDP target by 2020 will require,
"...perfect implementation...[and] a lot of luck...including a rebound in growth."
Notice the implication there: a rebound in growth is so far from likely that its realization could only be described as a lucky break, something Greece doesn't get a lot of.
Ultimately, this whole enterprise is designed to disguise the fact that the only way for Greece to experience real relief is for the official sector to write down its holdings of Greek debt. The following chart shows the breakdown of who owns Greece's debt:
(click to enlarge)Source: OpenEurope
Tinkering with private sector debt buybacks and repayment schedules doesn't change the fact that some 70% of Greek debt outstanding is held by the official sector and until this is written down this will be a losing battle. Essentially, the troika is simply manipulating the numerator of the debt-to-GDP ratio as much as they can using the 30% of Greece's debt held by the private sector and hoping that this will buy Athens enough time to get the denominator in the equation (GDP) moving.
This is an exercise in futility and it will continue to promote instability in the eurozone. Investors shouldn't use the Greek 'deal' as an excuse to jump into European equities (FEZ) and/or distressed sovereign debt. It will be quite some time before this is resolved and in the mean time, the best strategy is to either short everything European in anticipation of an eventual blow-up, or to stay comfortably above the fray.