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Monday, February 27, 2012

European Update

Greek Bailout Approved, Debt Exchange Offer Extended

Late Monday Eurozone finance ministers approved the second, €130bn, bailout for Greece, including a larger-than-expected haircut on privately held debt. In addition, Greece must still meet a list of "prior actions" before aid will be disbursed.

On Friday, Greece made a formal offer to bondholders to exchange €206bn of government debt for a 53.5% haircut in face value. The cuts amount to a nearly 75% loss in NPV for investors. According to the deal, investors will receive two-year, AAA bonds issued by the European Financial Stability Facility (EFSF). The remaining 31.5% of face value will be issued as Greek government bonds, maturing in 2023. The new bonds will pay a coupon of 2% for the next three years, 3% for the following five years, and 4.3% for the remaining maturity.

The bailout requires a permanent team of monitors in Greece to ensure bailout terms are abided by. Greece will be required to temporarily hold three months worth of bond payments in an escrow account, and Greek leaders have agreed to change the constitution to make debt repayment a top priority of government spending.

Official lenders have also increased their share in the bailout in order to get projected debt to GDP down to 120% of GDP by 2020. They have cut interest rates on bailout loans to 0.5% for the next 5 years and 1.5% from thereon. This is expected to cut an additional €1.4bn (2.2% of GDP) from Greece's debt burden.

See the formal bond exchange offer.

Sustainability Analysis Highlights Greece's Challenges

A confidential report circulated to finance ministers indicates that Greece may be worse off than previously thought and may need another bailout, past the one currently being discussed. The report warns that the current bailout may be making matters worse, as the forced austerity is actually causing debt levels to rise due to the blow to the economy. Moreover the €200bn debt restructuring could scare off future private investors and prevent the country from reentering financial markets.

The report indicated that "prolonged financial support on appropriate terms by the official sector may be necessary." The baseline scenario presented indicated that the proposed haircuts would only reduce debt to 129% of GDP by 2020.

The downside scenario presented in the report suggests that Greek debt may fall to only 160% of GDP by 2020 instead of the 120% required by the IMF bailout. Under this negative scenario Greece would require about €245bn in bailout funding, much more than the current €170 it is due to receive.

G20 Pressures Germany to Boost Rescue Fund

Finance ministers from the G20 have put pressure on Germany to boost the size of Europe's bailout fund, calling the move "essential" in their decision to contribute funds to the IMF. Some eurozone officials have called for the fund to be boosted to €750bn or even €1tn. Other nations have offered to contribute additional funds to the IMF but have stressed that "the IMF cannot substitute for the absence of a stronger European firewall." –Geithner

Germany has resisted an expansion of the ESM. On Wednesday, a German government spokesman said there was no reason to boost the size and that “the German government’s position has not changed. That means no.”

European Commission Forecasts Recession

According to the European Commission the Eurozone economy is experiencing a “mild recession,” yielding to modest growth in the second half of 2012. Overall the forecast calls for 0.3% contraction in 2012, an improvement from an earlier estimate of 0.5% contraction. Inflation is now forecast to be higher than previously expected at 2.3% in 2012. The forecast also noted there are still significant risks to “the downside amid still-high uncertainty,” going on to note, “the interim forecast relies on the assumption that adequate policy measures are decided and implemented.”

See the European Commission’s forecast.

Ahead this week

Monday - German lower house will vote on Greek bailout

Tuesday - Ireland to decide whether to hold a public referendum on porposed EU treaty changes.

Italian bond auction

Wednesday -
ECB holds unlimited issuance of 3-year funding

Finnish parliament will vote on Greek bailout

Friday - European Union leaders' summit

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