Considering the Risk of Sovereign Debt

 |  Includes: EU, EWA
by: Clemens Kownatzki

As the Wall Street Journal reported yesterday:

Greece continued to pay a stiff premium Monday to raise €5 billion ($6.71 billion) in its third syndicated bond offering of the year, a demonstration that the announcement last week of a possible European Union rescue package has done little to lower the troubled country's high cost of borrowing.

Compared with Greece's two previous bond issues in 2010, demand was relatively subdued. The seven-year bond attracted around €7 billion in bids. Greece's two earlier bond offerings this year had seen bids totaling three times what was eventually sold. Greece is paying a coupon of 5.9% on the new bond, 3.34 percentage points above what Germany pays to borrow money. The new €5 billion bond issue means Greece has now sold about €20 billion of bonds, or 43% of its 2010 target.

Call me naïve, ignorant or cynical but I have a hard time justifying this rate as adequate risk premium over what is still considered “risk-free”, i.e. US government securities. Yes, the Greek debt crisis has subsided since the Euro Member countries pledged some support for Greece last week. But Greece still has to sell another €26 billion of bonds until the end of this year, the outcome of which is far from certain. Hence, the market still wants more than a 3% premium over equivalent German Bonds.

I don’t know anyone personally who bought Greek government debt in the past and I fail to see why an institution or an international investor would want to do so now. Why should one lend money to the Greek government at 5.9% for 7 years when for instance the equivalent Bond from Australia, which from this vantage point appears in better economic shape than most European member countries, is yielding 5.68% –that’s just a fraction below those of Greece. Granted, a European investor might fear the currency exposure against the Australian Dollar. However, a non-Euro denominated investor such as an American institution would have a similar currency risk either via the Euro or via the Australian Dollar. Is Greece’s tiny premium of 0.22% over Australian Bonds really worth the seemingly higher proportionate risk?

Apparently, the market rates indicate that the chances of an Australian default are still lower than the possibility of European Union members letting Greece default. As time goes on and as the dust about Greece sovereign debt settles, Greek Bond yields should subside as well. At that point the Australian yield would probably be higher than those of Greece and would make my choice towards Australian over Greek debt an even more compelling one. For a US investor, there is of course still the question about currency risk, which needs to be assessed no matter what. However, that is a risk I personally feel much more comfortable with and am willing to take anytime over the uncertainty of Greek government finances sustaining for the next 7 years.

Disclosure: No positions