By Rebecca Christie
German Chancellor Angela Merkel and International Monetary Fund Managing Director Christine Lagarde will meet in Berlin Tuesday night as pressure grows to complete a Greek debt swap needed to put a rescue plan in place.
The deal, hammered out by European Union leaders, Greek officials and the nation’s creditors on Oct. 26, called for bondholders to accept a 50% cut in the face value of their Greek debt, with a goal of reducing Greece’s borrowings to 120 percent of gross domestic product by 2020.
More than two months after the accord was announced, creditors and authorities still need to agree on the coupon and maturity of the new bonds to determine the total losses investors would suffer. The IMF has sought a lower coupon than the range offered by investors to ensure Greece meets the deficit targets amid a worsening economic outlook. Failure to complete the voluntary swap threatens to further undermine confidence in the EU’s crisis leadership and deter investors from Asia and the U.S. from buying Europe’s debt.
“All non-European investors except a few bargain hunters will keep clear of investing in the euro area,” said Espen Furnes, an Oslo-based fund manager at Storebrand Asset Management, which oversees US$72-billion.
Ms. Merkel and French President Nicolas Sarkozy said Monday that the October European summit decisions on Greece have to be implemented.
“The voluntary restructuring of Greece’s debt must be moved forward,” Ms. Merkel told reporters after hosting Sarkozy for talks in Berlin. “In our view, the second Greek program, including the debt restructuring, has to be carried out quickly now because otherwise it won’t be possible to pay out the next tranche for Greece,” she said.
Ms. Merkel meets with Ms. Lagarde at 8 p.m. in Berlin Tuesday, while Mr. Sarkozy will meet Ms. Lagarde, the former French finance minister, Wednesday in Paris, his office said in a statement Tuesday.
Investors should brace for the prospect that bondholder losses could spread to other rescued nations, Citigroup Inc. Chief Economist Willem Buiter said yesterday.
In Ireland, “there clearly will be a need for either some form of official concessions on the terms and conditions of its financing” or other private-sector involvement in a debt restructuring, Mr. Buiter told reporters in Dublin yesterday. Portugal may also have to engage in a restructuring of its sovereign debt, he said.
There’s no point in speculating about a second aid program for Ireland when the first one is “delivering,” European Commission spokesman Amadeu Altafaj told reporters in Brussels Tuesday.
EU officials have emphasized that Greece’s circumstances are unique and don’t presage bondholder losses in other nations that seek assistance. The swap proposed to investors would slice 100-billion euros from the 205-billion euros of privately owned Greek debt. The new bonds will be backed by 30-billion euros of incentives, in the form of high-quality collateral issued by the euro area’s rescue fund.
After two years of wage cuts and tax increases, the IMF estimates Greece’s 2011 deficit at about 9% of gross domestic product, compared with 10.6% in 2010. The economy probably shrank about 6% last year, according to the latest IMF estimates, compared with a forecast of 3.8% in June.
Further delays in completing and implementing the debt swap and rescue plan may have greater consequences for the rest of the eurozone than Greece itself.
“Government debt markets are about trust,” European Central Bank council member Athanasios Orphanides wrote in a Jan. 5 Financial Times column. A “collective failure of euro- zone decision-makers” has been a prime cause of the contagion that drove up borrowing costs across the region, he said.
When policy makers began efforts to have private investors share the cost of debt crisis losses, they intended to curb moral hazard in borrowing nations, he wrote. The move also made clear to potential lenders that “eurozone sovereign debt should no longer be considered a safe asset with the implicit promise that it would be repaid in full,” Orphanides wrote.
Winning support from banks seeking to limit their losses will be easier than roping in hedge funds and other speculators who bought securities at distressed levels. For example, investors who purchased Greek bonds at 35 US cents or 40 US cents on the euro will want an agreement that allows them to profit from the swap.
For that reason, the final deal may have to incorporate a net-present-value loss of less than 60% to gain the participation needed to avert default and a series of lengthy legal battles, people familiar with the talks have said.
The net present value loss faced by participants in a Greek debt swap may “of course” exceed 50%, said Frank Vogl, a spokesman for the Institute of International Finance, in an e-mailed statement Monday. The IIF represents more than 450 global financial institutions, and its managing director, Charles Dallara, is co-chairman of the creditors’ steering committee taking part in discussions on the swap.
Vega Asset Management LLC resigned this month from a committee of Greek creditors negotiating the debt swap with European authorities because the Madrid-based hedge fund refused to accept a net present value loss exceeding 50%, according to a Dec. 7 email sent to other panel members, which was obtained by Bloomberg News.
“Vega needs to start considering all available legal options to refuse and challenge any exchange” that leads to a loss of more than 50%, Vega wrote in the e-mail. Vega Chief Executive Officer Ian Shackleton declined to comment on the hedge fund’s resignation from the committee.
New bonds may be sweetened with warrants that allow investors to receive a larger payment if Greece grows faster than expected. Such warrants would improve the potential returns for creditors, without locking Greece into higher payments if the economy continues to struggle.
Both sides have agreed that the new bonds should be governed by English law and that private bondholders should have the same seniority after the swap as the IMF and the European Financial Stability Facility, people familiar with the discussions have said. The sides have also agreed that the deal should include collective action clauses that would ensure lenders participate in the swap, the people said.
Talks between Greece and private creditors are proceeding at a satisfactory pace with discussions focused on what coupon the new bonds will carry, Deputy Finance Minister Filippos Sachinidis said in an interview on Real FM Radio today.