Flash Comment Greece: EU/IMF loan drawing closer

The developments in the Greek markets are very worrying, with Greek bonds getting dumped. More specifically, two-year Greek yield spreads to Germany have widened around 60p today alone (+220bp over 5-days and + 430bp since primo 2010). Two-year yields are thus trading around 7.20%, ten-year yields are trading around 7.35%. Earlier today the Greek yield curve had an inverse slope as two-year yields were as high as 7.76%.

Markets are today affected negatively by a story out on a Greek website, which is, according to sources, reporting that Commerzbank - one of the biggest repo counterparties to Greek institutions - was dumping bonds in yesterday's sell off. Not only that but it is now pulling repos, in essence starting a cascade of asset liquidation, in which banks, already experiencing a depositor run, will be forced to sell assets at any prices they can get just to fund their operations for one extra day. Read more here.

Other market drivers over the latest week:

1) Stories in the local media that last year’s budget deficit might be as high as 14% of GDP and that the EU will lower its growth forecast for Greece from minus 2% to minus 3% in 2010. In such cases, further tightening will be needed to reach this year’s deficit target (8.7% of GDP).

2) This week both the Daily Telegraph and Financial Times ran stories about “silent runs” on Greek banks in the first months of the year. According to the Greek central bank, local savers transferred about EUR10bn of deposits – equal to about 4.5 % of the total in the banking system – out of Greece in the first two months of the year. Yesterday the four largest Greek banks applied for access to EUR14bn in loan guarantees from the government and EUR3bn in government bonds.

3) Last week Greece saw one disappointing government bond auction and over the weekend said it would attempt to issue USD-denominated debt – aimed at potential US and Asian buyers. This raised fears that the market for euro-denominated debt is drying out.

Clearly, the current situation is unsustainable. Greek needs to restore market confidence, sooner rather than later. This can in our view not be done without more clarification on the EU/IMF deal. Greece needs cash very soon. Hence the developments over the last week have surely increased the chance of an IMF deal drawing closer. Yesterday an IMF mission arrived in Athens and is probably discussing potential conditionality with the Greek government as we speak. It is likely that IMF conditionality is reflecting the latest Greek austerity package. However, the IMF might demand even tougher adjustments, which could be politically intractable as the Greek administration promised its voters that there will be no further tightening. The Greek administration might however not have much to say about this. What are the alternatives given current market conditions? Another crucial question is whether an EU/IMF deal is enough to ensure more stable Greek markets? (continued overleaf)

Eventually we expect that such a deal should lead to declining volatility and narrower country spreads, but on the back of the large uncertainties and the lessons learned from Latvian and Hungary aid deals in late 2008, it is clear that it takes times to restore market credibility. Hence an IMF/EU loan might not be enough to bring spreads significantly down until we see evidence that Greece is successfully bringing its deficit down and debt developments can be brought back onto a sustainable path.

At the ECB’s monthly press conference today at 14.30 (CEST), Governor Trichet was thoroughly questioned about the Greek situation. He emphasized that the ECB was not against IMF involvement in a potential loan to Greece. However, he also emphasised that sovereign states should as far as possible aim at resolving fiscal challenges themselves. Asked about the ECB’s extension of temporary collateral rules, Mr Trichet said that it was not related to the development in a single country, e.g. Greece. We note that the extension of easier collateral rules is clearly positive for Greece.

Mr Trichet emphasized that taking all the information into account, default is not an issue for Greece and he indicated that it is in the hands of the Greek government to judge when the EU/IMF guarantee should be activated. Our assessment is that on the back of the latest developments, an EU/IMF loan could be drawing closer.