Greece: Bailout In The Mail, Not Enough Money In The Envelope

A fitful reaction from the markets to the news that the second bailout of Greece is much closer after eurozone finance ministers agreed to the latest bailout package.

Most Asian markets rose, all major European markets fell and US markets were cautious. Gold and oil rose, the euro rose, then dipped.

In fact the reaction was muted. The Dow hit 13,000 for the first time since May 2008, then retreated to end the day slightly down.

And the Australian dollar, a good global barometer for 'risk on' investing and confidence, sold off slightly overnight as investors worried about the deal working.

While the bailout grabbed the headlines, the chances of Greece being bailed out in the true sense of the phrase are receding because the 130 billion euro package won't be enough to give the stricken country long term stability.

The package will aim to reduce Greece's debts from around 160% of GDP now to 121% by 2020. That, according to a secret report obtained by the Financial Times, is pie in the sky stuff.

Instead, it looks increasingly likely that the country will need years of 'life support' measures from the rest of Europe to survive without default.

Greece would need extra aid to cut its debts near to the official debt target 2020, given the ever-worsening state of its economy and if the government doesn't do what it has said it will to improve its finances, its debt could hit 160% by 2020, meaning its position will be unchanged from where it is now.

In other words the 130 billion or more of spending on bailout packages ($US170 billion) will have been wasted.

The country is fading from depression to become what is essentially a black hole where the cost of keeping it alive and out of default may top the 240 billion euros (or close to $A290 billion), according to a secret report detailed by the Financial Times yesterday.

The FT said the report showed that Greece's finances are in worse shape than anyone will admit and there is every chance it will need one or two more bailouts between now and 2020.

FT says that the "strictly confidential" report on Greece's debt projections prepared for eurozone finance ministers reveals Athens' rescue program is way off track and suggests the Greek government may need another bail-out once a second rescue - agreed on yesterday afternoon, Australian time, runs out.

"The 10-page debt sustainability analysis, distributed to eurozone officials last week but obtained by the Financial Times on Monday night, found that even under the most optimistic scenario, the austerity measures being imposed on Athens risk a recession so deep that Greece will not be able to climb out of the debt hole over the course of a new three-year, €170bn bail-out."

That in turns threatens the world economy and financial markets face the possibility of years of sudden leaps and falls in confidence as Greece staggers from crisis to crisis.

And that in turn will undermine whatever confidence is happening in Italy, Portugal and Spain. Credit rating downgrades as we have seen since late last year, could become more regular for European countries and their banks and the European Central Bank could be lending a trillion euros or more to the area's banks for years to come to keep countries and banks alive.

The ECB has already lent 489 billion euros to 538 banks across Europe and has another auction of three year loans a week today.

Greece would be reduced to a zombie state, sullen, dependent on the goodwill of Europe's giants like Germany, or it could decide it's all too hard and default.

Greece is now expected to launch a private debt exchange on March 8 and complete it three days later. If that happens it means a 14.5-billion-euro bond repayment due on March 20 would be restructured, allowing Greece to avoid default.

Most of the money in the 130-billion-euro program will be used to finance the bond swap and ensure Greece's banking system remains stable: 30 billion euros will go to "sweeteners" to get the private sector to sign up to the swap, 23 billion will go to recapitalise Greek banks.

A further 35 billion euros will allow Greece to finance the buying back of the bonds, and 5.7 billion will go to paying off the interest accrued on the bonds being traded in.

Next to nothing will go directly to help the Greek economy. In other words, the banks and other bond holders get bailed out, ordinary Greeks will get unemployment, lower wages, lower pensions and years of near depression. But that is optimistic, as the FT report reveals.

But they are optimistic assumptions in the secret report.

In fact the FT suggests that Greece will need ongoing financial support in coming years, so weak is its economy and so poor had been its adherence to previously agreed austerity measures under the first 110 billion euro bailout.

The report said the total cost of bailing out Greece could reach 245 billion euros and it warns that "Forcing austerity on Greece could cause debt levels to rise by severely weakening the economy while its 200 billion euro debt restructuring could prevent Greece from ever returning to the financial markets by scaring off future private investors.

"Prolonged financial support on appropriate terms by the official sector may be necessary," the report said.

"A "tailored downside scenario" in the report suggests Greek debt could fall far more slowly than hoped, to only 160 per cent of economic output by 2020 - well below the target of 120 per cent set by the International Monetary Fund. Under such a scenario, Greece would need about €245bn in bail-out aid, far more than the €170bn under the "baseline" projections eurozone ministers were using in all-night negotiations in Brussels on Monday.

"The Greek authorities may not be able to deliver structural reforms and policy adjustments at the pace envisioned in the baseline," the pessimistic scenario warned, according to the FT report.

"Greater wage flexibility may in practice be resisted by economic agents; product and service market liberalisation may continue to be plagued by strong opposition from vested interests; and business environment reforms may also remain bogged down in bureaucratic delays.

"Even under a more favourable scenario, Greece could need an additional €50bn by the end of the decade on top of the €136bn in new funds until 2014 being debated by finance ministers on Monday night.

"That "baseline" scenario includes projections that the Greek economy stops shrinking next year and returns to 2.3 per cent growth in 2014."

"Details of what has gone off course in the report are long and daunting. A recapitalisation of Greek banks, originally projected to cost €30bn, will now cost €50bn.

"A Greek privatisation plan, originally to raise €50bn, will now be delayed by five years and bring in only €30bn by 2020."

In other words Greece has failed to do what it committed itself to doing in May of 2010 year and in late 2011.

Unemployment is running at 20.9%, and will rise. Tax collections are falling, growth has vanished.

The economy shrank 7% in the final quarter of last year compared to the last quarter of 2010.

It shrank 5% in the September quarter from a year earlier, so the plunge towards depression is accelerating, not slowing as it was supposed to be doing.

In fact the news is just as bad for the rest of Europe, for global financial markets and for banks in Australia (and home borrowers, small business, politicians and the RBA).

It means financial markets will find it difficult to settle and for interest rates to fall for sustained periods, even as the stockmarket rallies higher.

There could be periodic eruptions of volatility and blows to confidence as Greece moves in and out of the headlines, even as the global economy, led by the US, Germany and China, struggles back onto a growth path.

That will mean volatile funding rates for banks here and offshore and periods where we get rounds of complaints from banks about being under cost/revenue/profit pressures requiring higher interest rates.