Viewpoint: Negotiations over Greece still at a standstill.

Negotiations over Greece still at a standstill. Yet, developments have been positive on other fronts of the crisis…..

For professional investors and advisers only

The Japanese trade balance will be negative for years. The country’s status as net foreign lender now depends on net income from capitals: the strong yen, and an ageing population, are factors that cannot be ignored when assessing financing risks tied to public debt, now at 220% of GDP.

Negotiations with Greece over the PSI swap deal are still at a standstill. The terms of the swap would imply an NPV loss of 65-70% (due to waiver of 50% of capital, lengthening of maturities to 30 years, and a 3.5%-4% coupon). According to Juncker, it is essential that creditors waiver their request for an average coupon of 4%. In actual fact, it seems that negotiations are being hindered not only by the terms of the structuring of the new bonds, but also by political problems (potential involvement of the ECB) and legal ones (introduction of Collective Action Clauses). As regards the former issue, to date both the central bank and the German government have explicitly denied that institutional creditors will also accept to take part in any swaps; in particular, the exclusion of the share held by the ECB, estimated at EUR 40-45Bn, is an important aspect; major issues on this front are the implied seniority status that the bonds held in the ECB’s portfolio would acquire, if excluded from the PSI, over those held by the market, and the potential retroactive inclusion of CACs, that would make italmost impossible to exclude the ECB’s portfolio from the PSI. On the other hand, it is widely acknowledged that the size of the financing supplied by the second programme will have to be greater than initially estimated.

Apart from the Greek deadlock, however, developments have been positive on other fronts. Mrs. Lagarde said that the “firewall” must be large enough to “not have to be spent”, i.e. sufficient to act as a deterrent in the event of a crisis. From the Eurogroup meeting it emerged that details on the ESM will have to be defined on 20 February. The stabilisation mechanism will become operational by July, as already agreed at last December’s summit. The ministers of finance agreed that applications for support to the fund are subject to adoption of the new “fiscal compact”. It remains to be clarified whether Germany will allow the increase in the EFSF–ESM’s fire power to EUR 750Bn. Also in light of these developments, and beyond mounting tensions tied to Greek debt, the other peripheral markets performed well; the tightening of spreads on Italian bonds was especially significant, also vs. Spain and France.

Within this context, the European Council will attempt to reach a final agreement on the intergovernmental treaty known as “fiscal compact”. Any decision on the unfreezing of the second bailout package for Greece is subject to a positive outcome of negotiations on the PSI.

Important dates for the euro area debt crisis
30 January Italy: BTP auction
30 January European Council
14 February Italy: BTP auction (forecast: 6Bn; 25.8Bn reaching maturity)
20-21 February Eurogroup and Ecofin
24 February? G-20
29 February Greece: deadline for payment of the 8th tranche
01-02 March European Summit. Signing of the Intergovernmental Treaty and details on the ESM
12 March Eurogroup and Ecofin
14 March Italy: BTP auction (Intesa forecast: 8.5Bn – 14.8Bn reaching maturity)
20 March Greece: 14.5Bn in Greek bonds reaching maturity
29 March Italy: BTP auction (Intesa forecast: 9.2Bn)
30 March The Ministers of Finance of the European Union meet in Denmark
Source: EU, ECB, Bloomberg and Intesa Sanpaolo
(?) date to be confirmed
Note: Spain launches two medium-long term auctions on the first and third Thursdays of the month

The trend of Japan’s trade balance is currently being overlooked, but may have potentially risky implications. In December, the trade balance showed a new monthly deficit, and the balance in 2011 as a whole was markedly negative, at JPY -2.49 trillion. The substantial trade deficit is largely due to energy: since the earthquake, fuel imports have soared to face the plunge in power sector production capacity. This is a structural factor, that could keep the country’s trade balance negative for years to come. The deficit is further aggravated by the appreciation of the yen and by the production delocalisation in the manufacturing sector. To date, for the past thirty years or so, Japan has enjoyed a balance of payment surplus, thanks to both trade flows and investment income: Japan’s net creditor position has so far contributed to contain risks tied to the public debt, which has by now reached 220% of GDP. In the future, maintaining a balance of payment surplus will depend on the size of net investment income. For now, there are no signs of a reversal of the positive trend on this front: both portfolio flows (around 70% of capital income) and direct investments (27% of the total) are structurally positive. However, the country’s status as net foreign lender is now placed at risk by two factors. The persistent appreciation of the yen could impact the trend of net capital income; secondly, the ageing population may lead to a domestic savings gap in the not-too-distant future. Without the trade surplus buffer, risks to the financing of public debt increase considerably.


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