Sunday 4 December 2016

What happens to us if Greece defaults?

Published 19/06/2011 | 05:00

AS Greece lurches toward a seemingly inevitable debt default, the moment of truth is rapidly approaching for the eurozone.

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Unless a means can be found to overcome the systemic crises currently wracking the periphery, then the entire single currency project is doomed.

Another week another crisis now seems to be the eurozone's standard operating procedure. With the Papandreou government teetering on the brink of collapse, a Greek sovereign debt default now looks very much like a question of when rather than if.

While the IMF blinked last week and backed down on its threat not to advance the Greeks €12bn of cash agreed under the terms of the May 2010 bailout, it is now clear that the crisis has merely been postponed.

Meanwhile, Finance Minister Michael Noonan travelled to the United States where he announced plans to "burn" the Anglo Irish and Irish Nationwide senior bondholders -- a move that he must have known is anathema to the ECB, which has committed itself to a rigid policy of "no writedown" of government or senior bank debt.

It's difficult not to suspect that neither the timing nor the location of Noonan's statement was coincidental. While in the United States he had meetings with the IMF, which has adopted a far-less rigid policy on debt write-down than the ECB, and with treasury secretary Tim Geithner, the man accused by economist Morgan Kelly of vetoing a previous plan by the Irish Government to "burn" unguaranteed senior bank bondholders in November 2010.

Are we seeing the first signs of the emergence of an Irish Plan B? Does Noonan have a cunning plan for Ireland to hold out until Greece goes bust?

We can only hope so. Things can't go on like this. The failure of Greek prime minister George Papandreou to persuade the main opposition New Democracy party to join a national unity government, followed by several defections from his own ruling PASOK party leaves him looking like a lame duck.

With the €110bn May 2010 EU/IMF bailout having now clearly failed to achieve its objectives, what are Papandreou's chances of persuading his countrymen to accept the fresh round of austerity measures that the EU and IMF will demand before agreeing to a fresh bailout?

The markets have already made their decision with the yields on benchmark 10-year Greek government bonds now up to more than 17pc and it now costs €1.8m to insure €10m of Greek government bonds against the risk of default for just one year.

Those sort of prices indicate that investors are expecting a Greek debt default, and soon.

While things haven't quite reached that stage in this country yet, make no mistake about it, the outlook for Ireland is grim.

Last week, the yield on 10-year Irish government bonds soared to a post-euro high of 11.3pc and with most long-term Irish government bonds now trading at less than two-thirds of their face value it's clear that most buyers of Irish sovereign debt don't expect to get all of their money back either.

The market for credit default swaps, the instruments bond investors use to insure against the risk of default by bond issuers, is telling the same story.

Last week Irish CDS prices hit 7.71pc. In other words, it would cost you €771,000 to insure €10m of Irish government debt for one year and, as these contracts normally run for five years, the market is now pricing in a 38pc "haircut" on Irish government bonds at some stage between now and 2016.

Last week's love-in outside Government Buildings, as Taoiseach Enda Kenny and Tanaiste Eamon Gilmore celebrated their first 100 days in office, will have done nothing to ease the fears of bond investors.

While the promise of no income tax increases or social welfare cuts in next December's Budget will have played well with the electorate, it provides further evidence to the markets that we still aren't serious about getting to grips with our crisis.

When the cost of bailing out the banks and interest on the national debt is excluded, the Irish Government will still spend €11bn more than it collects in taxes this year.

Even when capital spending is excluded, the budget gap is still €5bn. In other words, the Irish Government is borrowing €100m every week just to fund ongoing day-to-day spending.

All eyes will be on next week's EU leaders' summit.

Will they be able to cobble together a package that, at least temporarily, staves off a Greek default; and would the markets buy it?

Far more likely is that some combination of political instability in Greece and the EU's inability to agree on anything will push Athens into a disorderly and messy default.

This could well prove to be the trigger for the break-up of the eurozone in its current form.

If, or more likely when, that happens, we're next in the firing line.

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