Greek sovereign debt: Exit closed?
Deadbeats or dominoes? It's the question of the day.
Fitch, the ratings agency, would say that its decision to downgrade Greek sovereign debt had nothing to do with events in Dubai. But ever since the Dubai World story broke, investors - and ratings agencies - have been taking a fresh look at the indebted countries on Europe's periphery, wondering whether any of these countries will be next (see my post of 27 November, Just a sideshow?).
Greece isn't the only country which would rather not have the extra attention. There's plenty for the likes of Latvia and Ireland to worry about as well, and a sombre warning for the UK, too - though, as Moody's made clear in its sombre assessment today, Britain is still a very long way from being Greece.
True, Alistair Darling is borrowing nearly as much as Greece this year - its deficit is nearly 13% of GDP, like ours. But there the comparison ends. At least for now.
Greek debt is forecast to rise to more than 130% of GDP by 2011, almost double the level forecast for the UK. And the IMF forecasts a Greek current account deficit this year of 11% of GDP.
There are not supposed to be any bail-outs for Eurozone economies who can't pay their bills - or no formal ones, anyway. The treaty establishing the single currency expressly forbids them. But for the past two years, Greece and other hard-pressed economies on the Eurozone's periphery have been getting the next best thing to a bail-out, courtesy of the ECB.
Here's how it works: indebted government sells lots of bonds to domestic banks; banks then use bonds as collateral to get shedloads of (nearly) free money from the ECB.
As well as achieving the avowed end of increasing liquidity in the European banking system, the policy had the unstated, but equally welcome (to many European officials) effect of propping up the demand for the indebted country's debt.
It's not a formal bailout. But it certainly helped.
Were it not for the ECB, the Greek government would have been paying a lot more for its debt, and worrying the ratings agencies long before today.
As this chart (courtesy of Capital Economics) shows, since the collapse of Lehmans, Greek banks have borrowed the equivalent of a tenth of their balance sheet from the European Central Bank. Irish banks have been almost as keen. We can't say for sure, but European central bank officials have assured me in the past that the collateral for much of this borrowing was domestic government bonds.
Traditionalists within the ECB didn't like all that "peripheral" sovereign debt landing on the ECB's balance sheet. Yet the politics of equal treatment within the Eurozone - plus a great desire to pre-empt the need for more formal support - meant that the traditionalists didn't get a choice. It was a case of noblesse oblige.
But now comes the tricky part. As part of its cheap liquidity policy, the ECB had been allowing banks to use BBB - that is, debt as collateral - a loosening of the usual rules. But that is due to run out at the end of 2010, with the ECB once again requiring A- or better.
That's a large part of why Greece has been hammered in the markets following today's downgrade to BBB+. Come next year, European officials (and not just Greek ones) may be asking Frankfurt to remain "flexible" a little longer. But there's a limit to what even back-door support from the ECB can do.
If the downgrade sticks, Greece will be under enormous pressure to do more to fix its fiscal hole, despite a weak economy. Ireland has already done it, and they're due to do it again tomorrow.
That is why the no-bail-out clause is there: it's supposed to give governments no alternative but to clean up their act. Germany was particularly insistent that the clause be there when the single currency was created. There would be no running to the Brussels - or Frankfurt - if governments got into a fix.
But that's the theory. European officials don't know how it will work when confronted with a real-life debt crisis within the Eurozone.
Investors have long suspected that the politicians would find a way round the clause if they had to - there are various possible get-outs in the Treaty should they decide to use them. But no-one knows for sure.
That's why there could be plenty more "busy" days for European sovereign bond traders in the months to come.