Grexit Averted but Eurozone Debt Problems Still a Headache

Protesters hold a large Greek flag at the anti-austerity
Michael Debets/Pacific Press/LightRocket via Getty ImagesProtesters hold a large Greek flag at the anti-austerity protest outside the Greek Parliament in Athens, Greece.
By John Geddie

LONDON -- At 86 billion euros, Greece's latest bailout package is less than 10 percent of the sum Italy and Spain need to borrow on markets before the end of 2017. The eurozone's debt problems are far from over.

With Athens offered a temporary solution, sovereign debt bankers are turning their focus to the scale of the refinancing needs in some of bloc's other indebted states as the interest rate cycle turns and the crutch of central bank bond-buying is set to be whipped away in just over a year.

No one is predicting investors will shun the likes of Spain and Italy, as they have with Greece. But the risk is that they demand a higher rate of interest at a time when both countries are struggling to get their debts back on a sustainable path.

Some investors even see a situation where borrowing costs and the economic recovery in the bloc becomes so lop-sided that the European Central Bank has to extend its quantitative easing, or QE, program beyond its scheduled September 2016 expiration.

"Debt-to-GDP reduction and structural reforms may not have happened quickly enough in countries such as Italy while the rest of the eurozone is progressing pretty well," said Neil Murray, head of pan-European fixed income at Aberdeen Asset Management.

"In which case, we will need more QE programs."

In Italy, where data showed public debt at a new record high of 2.2 trillion euros this week, the government has to refinance 635 billion euros of bonds by the end of 2017, a third of its outstanding debt.

Spain has to roll over 351 billion euros in the same period, also around a third of its debts.

Investor appetite for this debt has up until now been helped by a series of monetary easing measures which sent 10-year borrowing costs to record lows of around 1 percent in March.

But even with QE in full flow, yields have climbed some 100 basis points in the last few months -- a trend that is worrying the bankers that arrange bond sales for these sovereigns.

"It's a market where the gross amount of issuance is massively more than it has been in the past and rates are rising," said one banker on condition of anonymity.

"We have been in this virtuous cycle and it is coming to an end."

Via bond swaps and issuance of longer-dated debt, Spain and Italy have used this cheap borrowing to extend the average maturity of their debt and ease future pile-ups.

It has also marginally reduced the government's overall cost of debt servicing, but crucially not enough for it to stabilize its debts.

In order for a country to do that, the sum of growth and inflation rates must equal the debt-servicing cost as a percentage of gross domestic product unless the country can run a budget surplus before interest payments to cover it.

Forecasts from the OECD, show that by the end of this year, the debt ratios of both countries will still be rising.

This is important because without the numbing affect of cheap central bank money, investors will start to once again pay closer attention to economic fundamentals and demand a higher risk premium from those that have not been able to get their houses in order.

No other central bank has so far been able to halt QE after just one round, and for strategists such as Standard Life's Andrew Milligan, economic divergence in the bloc will only encourage the ECB to follow suit.

"Very sizable amounts of debt have been allowed to build up," said Milligan.

"Traditionally, those would be solved by default, inflation, currency devaluation or a fast growth environment -- all of those look extremely difficult for Europe."
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