Greece Gets Its Deal

We finally have a financing deal for Greece.  For those who haven’t been following the blow-by-blow, a summary is below.

A few quick observations:

Don’t pay much attention to headlines on long-term debt reduction.  This is a kick-the-can solution that defers hard decisions until 2013.  While Greece’s official creditors recognize that the new government has taken significant steps and that recent measures passed by Parliament are worth supporting, the program is widely seen as unrealistic and lacking credibility with markets. Greek debt remains too high, the government will struggle to meet the ambitious terms of the agreement, and a recovery from a deep recession seems a long way off.  A Greek exit from the euro zone and/or a comprehensive default on debt still is the most likely scenario.

Markets seem pleased that the deal involves meaningful official sector involvement (OSI) through debt and cash flow relief.  This is the most that Europe can do for now on OSI, given the multiple “red lines” creditor governments have set out.  Over the longer term, I’d still argue that these red lines need to be erased and a more comprehensive approach to OSI adopted.  But, for now, Greece sets the precedent for the rest of the European periphery.

This deal provides little “free” cash for the government to spend.  The vast bulk of the package provides for further recapitalization of the banks, repayment of arrears and maturing debt, and a debt buyback from private holders.  That leaves only a modest amount of discretionary fiscal spending for the next few months. As before, Greece will depend importantly on sales of government debt to Greek banks to finance itself, which in turn is made possible by liquidity from the ECB. That’s a new definition of recycling, whereby the monetary authority is the ultimate provider of financing to service official debts.

The IMF seems to be slowly getting comfortable with the agreement. Their disbursement is expected to follow completion of the buyback in December.

Summary of the Deal

Greece will receive financing totaling €43.7 billion, consisting of €10.6 billion for budgetary financing, €23.8 billion in European Financial Stability Facility (EFSF) bonds earmarked for bank recapitalization, and €9.3 billion to be paid in three tranches during the first quarter of 2013 if Greece meets the program conditions.  Final approval of the package is expected by December 13 after Parliamentary approvals and the debt buyback (see below), in order to finance a €5.4 billion redemption payment on December 14.

In support of the deal, EU governments agree to:

• An EFSF loan for debt buybacks of up to €10 billion of privately-held Greek bonds at prices prevailing before the deal (23 to 35 cents, depending on maturity). It is expected the bulk of the buybacks would be from Greek banks.
• A lowering by 100 basis points (bps) of the interest rate charged to Greece on loans provided by European governments through the Greek Loan Facility (GLF), to 50 bps above interbank rates (worth about €2 billion).
• A lowering by 10 bps of guarantee fee costs paid by Greece on the EFSF loans (reportedly worth €0.6 billion).
• An extension of the bilateral and EFSF loan maturities by 15 years and a deferral of Greek interest payments on EFSF loans by 10 years.
• A commitment to pass on to Greece future income on certain debt, such as the Securities Market Program (SMP) portfolio, which is reportedly worth at least €7 billion.

These measures aim to reduce the debt-to-GDP ratio to 124% of GDP in 2020 and to below 110% of GDP in 2022.