A Greek Tragedy

Since 2010, the ongoing problem of Greece’s sovereign debt has cast a cloud over the Eurozone. Following the global financial crisis of 2008, Greece’s debt levels began to grow at an alarming rate (as seen in the chart opposite) which cumulated in Greece formally asking the EU/IMF for assistance in April 2010, via an instalment of €45bn and a repayment of €8.5bn in respect of Greek Government debt which was due for repayment. This caused Greece’s credit rating to be cut to “junk” status by Standard & Poors, citing increased fears that the Greek Government may default. This, of course, exacerbated the problem, as Greek Bond yields rose substantially.

In exchange for the bailout funds, the Greek authorities imposed austerity measures which, understandably, did not go down well with the Greek population. These includes large increases in direct taxation, and public sector pay cuts. Following a damning EU-IMF audit earlier this year, which showed that the austerity measures, where implemented, had done very little to improve the situation, S&P lowered the Greek credit rating further to “CCC”, which is the lowest of any global sovereign debt. The latest bailout request came after the dissolution of the Greek Parliament, and concerns that Greece would not be able to meet its’ obligations for payment due on 15^th July. A Bill bringing in additional austerity measures passed narrowly though the Greek Parliament on 29^th June, and as a result, the EU and IMF will forward the next instalment of a £98bn loan.

What is clear that this is simply a “stop gap” aimed at avoiding an immediate crisis. Until Greece can show real prospects of economic growth and also show that the austerity measures – including a freeze on public sector pay, rapid increase in the pension age, a rise in VAT, and most importantly a clampdown on tax evasion – are having a meaningful effect, all the EU have done is kick the can down the road until the next crisis point. At least a default – where Greece fails to repay its’ interest or capital on its’ sovereign debt – has been avoided for now, but many analysts view the EU monies propping up the Greek economy as a default in all but name.

Indeed, the fact that Greece has been given another shot of adrenaline has also switched investors’ attention to other EU states in poor financial health. This week, all eyes are on Italy, where 10 year Bond yields have surged to 5.4%, over concerns that a number of Italian banks would fail impending stress tests. In the past six months, both Ireland and Portugal have received bailouts, after suffering dramatic increases in their Government Bond yields, which leads to the interest payments on sovereign debt to become unsustainable.

This “contagion” to other EU states is unlikely to stop any time soon. And whilst it is possible to delay a default and buy time for countries such as Greece, Ireland and Portugal, Spain and Italy are a whole different proposition. A default – either actual or technical – of either of these two giants would almost certainly bring the whole Euro zone project into question. And don’t forget the USA has its’ own issues, as they have hit their technical debt ceiling of $14.3 trillion, and without the approval of Congress by 2^nd August, the US would face an economic catastrophe. I do not doubt that a fresh law will be passed in time to increase the limit before this date; however, the sheer scale of US Sovereign debt is truly frightening. Whilst Equities markets have been running along their own agenda over the past twelve months, it is only a matter of time before markets will be severely jolted by the reality of the debt crisis facing EU nations and the US. I continue to recommend to clients that they adopt a cautious approach and keep a limit on exposure to risk assets, including Equities.