Why Greece is Still the Word

While, the German Constitutional Court ruling on ESM and implementation of Draghi's conditional proposals for the ECB to buy Spanish and Italian bonds are awaited, Greece is looming large. A German paper reported over the weekend that the deputy parliamentary leader for the CDU threatened that if Greece does not fulfill its obligations, Germany would veto any additional EFSF payments to Greece.

Before the weekend, Greece reported that its state budget deficit, which exclude state-managed enterprises, stood at 13.2 bln euros in the Jan-July period compared with a 14.8 bln euro target. Earlier today Greece reported its economy contracted 6.2% in Q2 over Q2 '11.

The consensus had expected a 7% contraction. The contraction in H1 is not as severe as what was experienced in H2 '11, but economic slump continues. Over the past five years, the economy has contracted by almost a fifth. Astoundingly, Greece reported that industrial output rose in June on a year-over-year basis for the first time in four years.

Even if the pace of contraction eases, further shrinkage is likely. The jobless rate continues to rise and for the 15-24 year, it is near 55%, the highest in Europe. The EC forecast the Greek economy would contract 4.7% this year, but despite the modest positive developments cited here, the risk is on the downside. S&P, for example, warned last week that the Greek economy will shrink by 10-11% cumulatively this year and next.

Greece has a debt held by the ECB coming due in a week's time. Greece has asked to exercise a 1-month grace period, but the ECB refused. It has sought a bridge loan in vain, waiting for the Troika to finish its report. Greece's fall back option will be implemented tomorrow. Greece will roughly double the size of its monthly 3-month bill sale and seeks to raise 3.3 bln euros.

Last month's 3-month bill auction produced a yields of 4.28%, down fractionally from 4.31% in June and 4.34% in May. The primary participants tomorrow will likely be Greek banks, who can use the T-bills they buy as collateral with the Greek central bank to borrow more funds.

Meanwhile the Greek government continues to debate where to impose the additional austerity that the Troika are demanding. About 6.5 bln euros of the 11.5 bln demanded have been agreed upon for 2013 and 2014. The remainder is expected to come from additional cuts in pensions and public sector jobs.

The most likely scenario, we think, is that the Greek government will approve the new austerity measures by late September, giving the Troika little choice but to approve the next tranche of aid in October. Given the other larger issues that will come to the fore in the coming weeks, this is one can that may be better to kick down the road one more time.