By GRAHAM FROST 26/02/2010
In recent weeks, the mood of optimism in bond markets evaporated and the culprit appears to be Greece.
Over a decade ago, Russia defaulted on external debt approximately one fifth the size of Greece’s current position, hence the angst. Greece is viewed as living beyond its means with little will to address the matter.
Greece is in the Euro though, so does that make a difference?
To leave the Eurozone would be suicidal for Greece, as it would push up the cost of borrowing for a country that is already overburdened by debt repayments. For an Economic and Monetary Union member to default is clearly problematic for the rest of the members.
The Eurozone has a no bail out policy but cannot afford for this crisis to spread to other countries with potentially weak finances (Italy, Spain and Portugal), so how to help Greece through the crisis? Calling in the International Monetary Fund to help would mean a loss of face, hence the reason that Germany and France are thinking about unilateral aid and there are even suggestions that Euroland should set up its own IMF equivalent. In the interim, and without the ability to devalue its currency to regain competitiveness, Greece is being pressured to implement austerity packages - cutting government expenditure, lowering wages, increasing taxes and unemployment. This is hardly a vote catching strategy for politicians - but it is exactly what other countries, like the UK, will have to come to terms with in the years ahead.
The Organisation for Economic Co-operation and Development (OECD) estimates that its 30 member country governments will borrow $16 trillion this year. They can hardly afford a buyers strike. That would push up their borrowing rates, which in turn would drag up yields and push down prices in other debt instruments. This is the main risk for bond investors and requires continued vigilance. Greece needs to rollover maturing debt of €25 billion in April/May, so a solution is needed soon. We expect one to be found.
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