On Oct 21, Greece received 8b payment from the troika, the sixth installment of 110b bailout negotiated in May 2010. In a previous article on when Greece will likely to default, we believed that a Greek default is beneficial to Greece. Default on their current debt will help Greek government with their cash flow and improve their finances faster. They would not be able to borrow after default, but the easement on the current debt would allow them to better live within their cash flow.

 

What will be the real problem if Greece defaults

The real problem lies in the financial sector, in not only Greece but also other countries where banks are exposed to Greek sovereign debts. According to a list of banks’ exposure to Greek debt earlier this year, only Greek banks and a Cyprus bank have heavy exposure as percentage of asset to Greek sovereign debt. All other banks only have 1% of assets or less exposed to Greece default risks. If that remains the case today, the direct effect of Greece default on the financial sector outside of Greece will not be large, regardless of whether the haircut will be 20% or 50%.

The real problem is that Greece is not alone, the GDP of Greece only accounts for 3% of the entire Euro 17 countries, Ireland and Portugal accounts for 2% each. The real problem will be the relatively larger countries, who are also in trouble, namely Spain, Italy and even France, who accounts for 12%, 17% and 20% respectively of eurozone GDP.

How much sovereign debt do the troubled European countries have outstanding in total?

According to eurostat, by the end 0f 2010, the government debt outstanding is as the follows:

Spain, Italy and France together has more than 4 trillion of outstanding debt by the end of 2010. If any of these governments cannot meet their obligations, the current 1 trillion EFSF in discussion is insufficient to help. (Note the fact that part of the EFSF itself is backed up by the troubled countries).

 

How long can the ECB buy sovereign debt of troubled countries?

The European Central Bank (ECB) has been purchasing government bonds of the troubled countries from banks and private sector, and will keep doing so to help stabilizing the market, according to the new president Draghi.

The latest ECB consolidated balance sheet shows a total for September of €27,065b, an increase of  €1,253.8b from the end of 2010. If the ECB is willing to expand its balance sheet, then purchases can go on for a long time. This will result in inflation causing higher nominal GDP and lower debt to GDP ratio. Also debt will be easier to repay.

But the ECB has said that they will not finance governments. Furthermore, there is a “no-bail-out clause” (Article 125) of the Treaty on the Functioning of the European Union.

 

On October 27, 2011, a voluntary 50% reduction of Greek sovereign debt by the private holders was agreed to. Now projections of debt to GDP have reduced to 120%. Greece will do everything it can to get funds from outside of the country to sustain its spending. When the day comes that they cannot get the money, they will default.