Greece Is The Word

Andreas Utermann, Global CIO at RCM, an Allianz Global Investors company, discusses the risks posed by Greece

The vote of confidence that George Papandreou, the Greek Prime Minister, won yesterday should not be seen as the beginning of the end but rather the end of the beginning of the European Sovereign Debt Crisis.

The structural problems within the Greek economy, but also within some of the peripheral economies, including Italy, are so severe that they will take years of reforms to address and resolve. 

European policymakers know this as much as financial markets and hence the current moves towards ‘resolving the crisis’ are no more than attempts to buy time to allow the European political structures and the financial system to adjust to the eventual restructuring of some of the peripheral debt.

In this, the key players are:

1.       Germany and France who need to foot the bill and whose political leaders need to demonstrate to their electorates that they are getting the best deal possible for the inevitable bailouts.  These countries also realise that they are the main beneficiaries of the EMU in its current guise;

2.       The ECB which needs to be seen to be continuing to be the guardian of sound money and can usefully play ‘bad cop’;

3.       The politicians of the peripheral countries whose main task it is not to be seen to be taken advantage of and persuading their own electorates that the sacrifices demanded are worthwhile.

The European banking community are willing participants and supporters of this slow workout process which, coupled with a continued steep yield curve allows them to restructure their balance sheets to make them more resilient.

The current painful and at times seemingly indecisive European resolution mechanism will continue until such time that structural reforms that are being implemented in the periphery are bearing fruit, budget balances have been restored and the European banking sector is capable of absorbing sovereign debt write-offs. It is at this point only that any debt restructuring involving writing off some of the principal will be discussed in earnest. 

In the meantime private sector participation is already occurring via the discounted sales of paper to the ECB (and possibly in the future, to the European Stability Fund), potentially providing capital appreciation should this paper be repaid at par or higher levels than the markets are currently anticipating.

 The increasing risk in all this of course is that the European electorates will grow tired of this process and force the exit of the periphery, leaving behind only a core EMU.  We do not consider this the most likely outcome. Be braced for further volatility.”