Eurozone Crisis: Greek 'Haircut' Deal Within Touching Distance

Greek 'Haircut' Deal Within Touching Distance

Hopes are rising that an agreement to write off large amounts of Greece's debt can be reached in the near term, easing growing concerns in the markets that the country was stumbling towards defaulting on its debts.

Talks between the Greek government and its private sector creditors are set to resume at 1730 GMT, after a conference call between eurozone finance ministry officials. The two parties are trying to agree on a debt-swap deal that will see investors take a hit on the value of their bonds, exchanging them for lower-valued, longer-dated paper.

Agreeing this "private sector involvement" (PSI) is a condition of an official bailout package, without which Greece will be unable to pay off debts totalling €14.4bn, due on March 20.

Officials from the country met with the Institute for International Finance (IIF), which is negotiating on behalf of private investors, on Thursday, in talks that the IIF said were "constructive". The tone has changed dramatically from a week ago, when discussions broke down over a reported failure to agree on the interest rate, or "coupon" to be paid on the newly issued bonds.

The details of the swap, if agreed, will be closely watched by the markets.

UBS economist Stephane Deo is forecasting a 70% "haircut" and a bond-swap deal that sees the current debt exchanged for new paper with longer maturities, giving the country more time to pay back what it owes.

If the agreement is voluntary and has enough participation amongst bondholders to prevent the Greek government going through with its threats to force it through, then it should not, as the rating agency Standard & Poor's said, constitute a default, Charles Jenkins, regional director for Western Europe at the Economist Intelligence Unit, said.

Greece is struggling under €350bn of debt - around 160% of its gross domestic product (GDP). This deal could wipe as much as €100bn off its burden, but with growth still negative and its government budget still in deficit, it is a long way from fixing its underlying problems.

Jenkins, like many other analysts, believes that the country's official creditors - the European Union and the European Central Bank (ECB) - will also need to take a hit on their holdings.

"There are huge systemic problems that are not going to be solved by a haircut. But it's more sensible to do it than not to do it," he told the Huffington Post UK. "I would assume that the official creditors are at some stage going to have to accept a haircut as well."

The "voluntary" nature of the swap is also in question, with the prospect of a "collective action clause" (CAC) enforcing the deal across all of the country's private sector creditors.

In that scenario, the ECB could end up having to take part in the write-down, despite having previously insisted that it would not, Deo said. That would mean incurring losses of around €22bn on its holdings of Greek debt, according to estimates from UBS.

However, as UBS said, the losses would be shared across the entire "Eurosystem" of national central banks in the eurozone, which is more than capable of absorbing the figure, especially given that the ECB will receive quite generous returns on its investments in other sovereign debt and through its other banking operations.

If the settlement is seen as anything but voluntary, however, it could have a larger spillover effect in the financial system by triggering credit default swaps (CDS), which are effectively bets against the country paying its debt back.

These financial instruments pay out in the event of a technical default. They were designed as risk management tools, offering buyers of bonds insurance in the event of countries and companies becoming insolvent. However, they have increasingly been used by hedge funds as investments in their own right, allowing investors to take a punt on a potential default.

These instruments have been traded on in relatively opaque secondary markets, and where they are is difficult to know. However, the payouts for the contracts are likely to be large, and could have knock-on effects on liquidity and confidence in the financial sector in Europe. The absolute size of the payouts is hard to estimate.

An enforced write-down would also be likely to lead to a large number of legal cases, putting further pressure on the embattled country's resources and credibility.

Beyond the direct financial impact, the knock to confidence could be huge. While now hardly unexpected, a Greek default would mark the first by an ostensibly developed economy in recent history, and the first in the eurozone - both almost unthinkable 18 months ago. It would put even more pressure on other sovereigns seen as vulnerable by the markets, and even further undermine perceptions of risk in the eurozone.

Ultimately it is up to the International Swaps and Derivatives Association (ISDA) to decide whether or not the final agreement constitutes a "credit event" and triggers the CDS. The consensus view in the market is that a technical default will be avoided, however.

The euro pulled back from a two-week high against the dollar after Thursday's optimism, as traders took profits and trimmed their exposure ahead of an expected announcement on Friday evening.


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