Weekly Update - Beware of Greeks bearing (bond) gifts

The Summary 

Greek government bond (GGB) yields fell this week below 1%, reaching the lowest level on record. Only eight years ago, on February 14th 2012, GGBs yielded 33%. However, Greek government debt remains an enormous burden on the economy – at 180% of gross domestic product (GDP), its debt is three times larger than the maximum enshrined in the Maastricht Treaty. What caused the collapse in yields? And what are the implications for the euro zone?
In the aftermath of the financial crisis of 2007-2008 and the euro zone sovereign debt crisis in 2010-2012, Greece’s mishandling of the economy and misreporting of its deficits led to reform, austerity and a severe recession which shrunk GDP by over one quarter. The collapse in GDP pushed debt-to GDP ratios from 127% in 2009 to current levels while Greece sought bail-outs from the International Monetary Fund, the Eurogroup and the European Central Bank (ECB).
Greece underwent three successive economic adjustment programmes overseen by these three institutions (known as the troika), meeting a number of commitments, albeit with extreme difficulty, before finally exiting the bailouts on August 20th 2018.
The final agreement extended maturities on around one-third of Greek debt by ten years and instituted a ten-year grace period for interest and amortisation payments on those loans, providing much-needed relief to the government’s debt-service burden.
Under troika guidance, Greece’s government finances began to come under control. Expenditure was slashed and taxcollection systems improved, enabling Greece to promise to achieve a primary budget surplus (i.e., before the cost of servicing its debt) of 3.5% of GDP each year until 2022, continuing the run of surpluses each year since 2015 (see chart). And thanks to the partial grace period on interest, the overall budget balance is now back in surplus too.
Although much of the implementation of the bailout plan was carried out by the radical-left Syriza government, July 2019’s election saw the centre-right New Democracy party back in power. The return of a more business-friendly government was well received, with manufacturing PMI confidence up to 54.4, the second-highest level in the world, and consumer confidence at a two-decade high (see chart).
The better economic performance has encouraged rating agencies to take a more positive view on GGBs. Recently, Fitch lifted Greece’s credit rating to BB and the other agencies have their ratings on positive outlook. However, Fitch still rates Greece two levels below the investment grade level which would qualify GGBs for the ECB’s asset purchase programme.
Nonetheless, Greece still faces enormous challenges in addition to its debt burden. Foremost amongst these is the ratio of non-performing loans (NPLs) on bank balance sheets, which stood at 37.4% at end Q3 on ECB data, over twice as high as Cyprus at 17.5% followed by Portugal at 10% and Italy at 7%. Greece recently gained approval for its Hercules programme to transfer EUR30bn of NPLs to a special-purpose vehicle for securitisation and sale. However, completion of this scheme would still leave the NPL ratio around 25%, far too high for comfort.

Bottom line. GGBs have benefited from a combination of factors – improved public finances, better economic performance and their positive yields in a region dominated by negative-yielding bonds. However, Greece remains an economy in convalescence for which the return to a sustainable level of public debt will take decades. Moreover, as underlined recently by Christine Lagarde, the euro zone still needs to complete its Economic and Monetary Union to provide a supportive framework for its weakest members such as Greece. We would caution against chasing GGBs at such low levels of yield.

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