Pressure on Greece Mounts, New Crisis Looms

The problem is uncomfortably familiar.  Greece has a chunky payment due to its official creditors.  Reports suggest that Greece has not completed much more than a third of the measures that had been agreed upon free up the next aid tranche from the 86 bln euro package.   

Time is working against Greece.  The elections in France and Germany do not provide a conducive backdrop for concessions, and public support for the Greek government is sliding.  Given the political context, it is important that Greece's measures are implemented ahead of the February 20 Eurogroup meeting.  

If this window of opportunity is not met, the situation could deteriorate quickly.  The more Prime Minister Tsipras enacts the reforms demanded by the creditors, the less the public supports him.  Many still suspect Greece is headed toward an election this year.  Since in some respects, Tsipras speaks the language of populism, a change in governments would likely be in the direction of the center, such as the New Democracy.  

Currently, the official creditors expect Greece to hit its fiscal targets this year.  The problem is 2018.   The key target is the primary surplus (budget balance before debt servicing).  The primary surplus in 2016 was estimated at 2.3% (of GDP).  Starting in 2018, the agreement calls for a goal of a 3.5% primary surplus.  The IMF has been insisting that considerably more dramatic action by Greece is necessary if the other official creditors refuse to reduce the debt burden, which the multilateral lender says is unsustainable.  

The IMF has refused to participate in the latest (the third) package, though German officials are quoted saying they continue to assume the IMF will join it.  The proximate cause of the current sell-off is a leaked draft of an IMF report, which warns that Greece's needs are approaching "explosive" territory.  On February 6, the IMF board meets to discuss Greece's debt-servicing capacity.  In order to reach the primary budget surplus goal, the IMF argues Greece needs to cut state pensions and the tax-free allowance of 5k euros on personal income.  

Greece's markets have responded violently to the new round of brinkmanship.  Greece's generic two-year yield rose 106 bp today to close at 8.65%.  From last Wednesday's low yield point of 6.66% to today's high of 8.75%, the increase is a little more than 200 bp.  The generic 10-year yield jumped 43 bp to 7.61%.  Last week's low yield print was 6.86%.  The 10-year yield briefly below 6.5% early last month.  

Greek stocks fell 3.5% today, which is about half of the loss suffered since last Thursday's meeting ended without an agreement.  Today's loss was led by the financials, which were off 6.5%.  From mid-September through mid-January, Greek shares rallied a little more than 22%.  It has now given back nearly half those gains.  

The sell-off of Greek assets is not the same thing as sales of the euro.  The euro is little changed in a relatively large range today.  The single currency is at the upper end of where it has traded since mid-November.  The problems in Greece coupled with approaching French election and Italian challenges (and possible election near mid-year) is producing a dramatic widening of premiums over German Bunds.  The Greek and Italian premium on 10-year bonds over Germany has widened by 25 bp over the past month.  The French premium has widened by half as much.  Spain has kept pace with Germany, and its premium has narrowed by less than a basis point over the past month. 

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