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Simon Johnson

Simon Johnson

Posted: April 11, 2010 11:20 PM

Greece Saved For Now - Is Portugal Next?

What's Your Reaction:

By Peter Boone and Simon Johnson

Crossposted on BaselineScenario.com

The Europeans announced Sunday they would provide 30 billion euros of assistance to Greece, amid informed rumors that the IMF will offer another 10-15 billion.  With a total of say 40-45 billion euros in the bag - more than the market was expecting -- the Greeks have time to make changes. 

The Greek government, helped by the market threat of a near term collapse, appear to have strong armed the other eurozone countries into a generous package without making efforts to change seriously their (Greek) fiscal policy.  This is good for near term calm, but it does not solve any of the inherent problems now manifest in the eurozone.

Often assistance packages of this nature just help "smart money" to get out ahead of a default.  This could be the case here; 40-45 billion euros total money could last roughly one year.  Both Russia and Argentina got large packages in the late 1990s but never regained access to private markets, so eventually everything fell apart.

Sunday's package should make it possible for Greece to borrow short-term but it takes courage to lend for 5 or 10 years to the Greeks unless there is much more fundamental change.

There are two key things to watch for:

1)  Is the global recovery so strong that Greek's economy picks up fast and their budget deficit comes down sharply?

2)  Will the IMF and Greeks now come up with a real austerity program that sharply cuts the deficit so that a year from now, when the official bailout money could run out, the market is receptive to Greek debt?

The danger for private debt holders is clear:  Sovereign loans invariably treated better in a restructuring than private debt.  So the European aid in some sense squeezes private debt holders.  They will be pleased there is no near term default, but it means their recovery value has gone down if things get bad again.  Greek long term yields will probably stay high.  The key market reaction to watch over the next 6-12 months is long term yields, and whether these come down to levels that imply low risk of default.

And there is still definite risk of contagion.  The actions of the EU show they are willing to intervene when yields get up to 7-8% on long term debt and markets close off to a nation. 

What does this really mean for Portugal or Ireland?  People holding Greek debt lost a lot of money in the last few months.  That will not come back soon, as markets will for a long time be wary of buying their debt - especially when Fitch just took the Greek rating to BBB minus, i.e., at the floor where the ECB now lets banks borrow against ("repo") government debt.  

The Portuguese therefore are not at all out of the woods.  If they do not start making serious moves towards cutting their deficit, they are next for a test. 

Surely the eurozone will bail Portugal out also - but where would it stop after that?  The stronger Europeans, by coming to Greece's rescue at this time with little conditionality, are effectively showing all the weaker nations that they too can get a package.  This will undoubtedly reduce the resolve for needed fiscal reforms across the European periphery. 

We are still lurching from crisis to crisis in Europe.