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26/09/2016

How the eurozone survived the Greek crisis

Euro & Finance

How the eurozone survived the Greek crisis

Burning greek euro coin

[Shutterstock]

The Greek crisis has strained nerves on the eurozone debt market, but unlike four years ago there has been no contagion of financial uncertainty across the single currency bloc.

The chaotic nature of the bailout negotiations which nearly sent Greece into default exacerbated market volatility, but the rise in yields was largely confined to Greek bonds.

While in 2011 Greece’s problems rippled across the eurozone as spooked investors demanded higher returns from other countries that in turn pushed them into financial trouble, this time yields barely budged.

This year “there was pollution, but not contagion” to other eurozone countries, said Patrick Jacq, a debt market specialist at French bank BNP Paribas.

“There was no contagion, that is the big difference with three or four years ago,” said Frederic Gabizon, who heads up bond markets at HSBC.

In a sort of self-fulfilling prophecy four years ago, investors worried about the sustainability of the debt of weak eurozone nations demanded higher returns. This weakened the finances of those countries.

Portugal ended up needing to take an full EU-IMF bailout in 2011 while Spain got away with just a bailout of its banks in 2012.

This year, even at the most difficult moments in the negotiations between Greece and its creditors “there weren’t massive movements to sell the bonds” of Spain or Italy, said Gabizon.

Bond market specialist Jean-Francois Robin at the investment bank Natixis said “the magnitude is completely different” this year.

He cited as an example the rate of return to investors on ten year Portugese sovereign bonds, which shot up to 18% at the beginning of 2012 but only rose to 3% this time.

The first bond emission by the European Union after Athens and the eurozone nations agreed on a third bailout to Greece worth up to €86 billion ($94 billion), demonstrated the confidence of investors, said Gabizon, who led the operation.

“In just one hour and 15 minutes it generated demand of €1.8 billion, or three times the €600 million the EU wanted to borrow for five years, for a borrowing rate of 0.272%, a real success,” he said.

The ECB is there

The reaction by markets this time around demonstrated the situation had changed significantly since 2011.

“The eurozone is better organised, and member states are also in a different shape. Portugal and Spain have undertaken considerable reforms,” said Robin, adding that economic growth has also resumed.

“Above all the European Central Bank is out there buying bonds every day,” added Robin, referring to the quantitative easing (QE) programme launched in March, under which the ECB purchases around €60 billion of debt of eurozone member countries and companies.

The programme provides powerful support to bond markets and keeps interest rates low. But even that didn’t prevent an upward swing in the second quarter of the year.

In the first quarter, galvanised by the ECB’s announcement of its QE programme, sovereign yields dropped,in some cases into negative territory, as investors sought a safe haven investment amid fears of recession and deflation.

“(But) the second quarter was very tumultuous,” said Jacq, citing two periods of significant rises in bond yields.

And analysts agreed that Greece played no role in those surges, which began before a Greek euro exit had become a serious possibility.

“There were several catalysts, including better than expected economic statistics and declarations by market heavyweights arguing rates were too low and calling for a sell-off. That’s when the market took off,” said Jacq, who anticipates more placid activity in the near term.

“The summer should be calmer […] but come September – between the looming rate rise by the US Federal Reserve and negotiations on Greece’s debt restructuring – volatility could make its return,” said Robin.

Background

Eurozone leaders reached an agreement on a programme to save Greece from bankruptcy after 17-hour talks on 13 July.

>> Read: Eurozone reaches ‘laborious’ tentative deal on Greece

If approved, this will be the third rescue programme for Greece in five years. It will be managed by the European Stability Mechanism (ESM), the eurozone permanent crisis resolution fund that was initially set up five years ago in an effort to save Athens from bankruptcy.

Here is a look at what Greece must do:

  • request continued support from the International Monetary Fund after its current IMF program expires in early 2016
  • streamline consumer tax and broaden the tax base to increase revenue. Laws on this are due by Wednesday
  • make multiple reforms to the pension system to make it financially viable. Initial reforms are due by Wednesday, others by October
  • safeguard the independence of the country's statistics agency
  • introduce laws by Wednesday that would ensure "quasi-automatic spending cuts" if the government misses its budget surplus targets
  • overhaul the civil justice system by 22 July to make it more efficient and reduce costs
  • carry out product market reforms that include allowing stores to open on Sundays, broadening sales periods, opening up pharmacy ownership, reforming the bakeries and milk market and opening up closed and protected professions, including ferry transport
  • privatise the electricity transmission network operator unless alternative measures with the same effect can be found
  • overhaul the labour market. This includes reviewing collective bargaining, industrial action and collective dismissal regulations
  • tackle banks' non-performing loans and strengthen bank governance
  • significantly increase the privatization program, transferring €50 billion worth of Greek assets to an independent fund, based in Greece, to carry out the privatisations
  • modernise, strengthen and reduce the costs of Greek administration, with a first proposal to be provided by 20 July
  • allow members of the three institutions overseeing Greece’s reforms - the European Central Bank, IMF and European Commission, previously known as the 'troika" - to return to Athens. The government must consult with the institutions on all relevant draft legislation before submitting it to public consultation or to parliament
  • reexamine, with a view to amend, legislation passed in the last six months that is deemed to have backtracked on previous bailout commitments.