What the Greek Deal Does and Does Not Do

For investors, the most important thing about the successful review of Greece's implementation of last year's agreement is that it effectively removes it from the list of potential disruptive factors in the coming quarters.   There will be no repeat of last year's drama. 

Assuming Greece resolves a few outstanding issues in the coming days, it will be given roughly 7.5 bln euros next month and another three bln euros over the summer.  The funds will be in Greece's hands for the shortest of periods.  The lion's share of the money is not for Greece, though the ideological language continues to call it a bailout of Greece.  Greece is not made whole.  Its debt burden is higher than ever.  The social and economic costs are among the highest that any country has born in modern times. 

If Greece is not being bailed out, who is?  Greece's creditors, mostly official, are being kept whole through this paper charade.  Greece is borrowing more money to pay the ECB for a maturing bond.  It also has payments due to the IMF in June and July.  Also, the Greek government has slipped into arrears with some domestic service providers and can pay its way out. 

The ECB now faces a couple of decisions.  First, recall that for the past year the ECB has not accepted Greek government bonds as collateral for loans to Greek banks.  This has forced Greek banks to access the ELA facility of the Greece’s central bank.  These funds come at a higher cost.  With Greece passing its first review, the ECB can decide as early as the June 2 meeting to once again accept Greek government bonds as collateral.  This could save Greek banks as much as 500 mln euros a year in interest servicing costs.   If the ECB refrains from doing so, it risks disappointing investors. 

The second decision that ECB faces regards including Greek bonds in its asset purchase operation.  The ECB could waive its own rules to include Greek bonds.  However, this seems considerably less likely than accepting Greek bonds as collateral.    Putting more Greek bonds on the ECB's balance sheet seems like a bigger commitment than accepting them as collateral on loans. 

The price that Draghi may have to pay for his unorthodox policies is more orthodoxy in other areas.  It is not clear that Greece's debt is sustainable.  Many doubt it, despite the spin some European officials have tried. Before the protracted negotiations, the IMF was insisting that the EU's plans unrealistic.  The idea that Greece will be able to run a 3.5% primary budget surplus over the medium term is absurd.  The IMF argued for a target less than half the size (1.5%).  The IMF also argued for what it called more realistic economic projections than the EU offered. 

The IMF made what some would see as a strategic retreat.  It chose to capitulate now and fight later.  Its capitulation was to sign off on the agreement even though the debt relief that it had insisted on as a precondition is a little more than vague suggestions until the end of the current program (2018).  It appears, to the cynical eye, that German domestic political considerations (next year's election) trumped the debt sustainability issue for now. 

However, the IMF has not ponied up more funds.  It will conduct a new debt sustainability analysis, incorporating today's agreement, before the end of the year.  It will likely be after the second review of Greece's progress in the fall, which could free up another two bln euros in funds if Greece continues to implement last year's agreement.  The new measures will include a revamping of the privatization program, reforming laws on bank governance, and restructuring the energy sector. 

Moody's responded almost immediately to the deal.  Seemingly ironically it suggested that borrowing more money (or getting access to funds that were already earmarked for it) was positive of Greece's creditworthiness.  Of course, the risk of a liquidity squeeze was alleviated, but that says nothing about its solvency.  The rating agency also found merit in the vague "road map on debt relief."    Its caveat was with implementation risk, and the small ruling majority Tsipras has to work with as nearly every austerity measure being pushed through parliament comes at a political cost. 

Moody's is set to review Greece's debt on June 24.  It currently rates Greece as a Caa3 credit (CCC-), the lowest of the big three rating agencies.  Our proprietary rating model puts Greece as B-, which is the same as S&P.  Moody's has a stable outlook for Greece. 

We caution investors against concluding that the agreement clears the way to buy Greek assets.   Investors have been anticipating something like what has materialized.  Consider that the Athens Stock Exchange has rallied nearly 54% since the mid-February lows.  After pushing higher earlier, the market reversed and closed more than 1% lower.  Today's loss was led by the financial sector, which dropped 3%.  

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