Greek Business File, April-May 2020, No 125
By Dimitris Kontogiannis
The ECB comes to the rescue of Greek bonds as Covid-19 hits
Greek yields fell sharply across the board in February but spiked a month later on concerns about the impact of Covid-19 on the economy. The ECB’s surprise move to buy Greek bonds in its new, 750 billion euro debt-buyback stimulus program was a game changer with the Covid 19 outbreak playing a key role in knocking down one of the previous crisis-era barriers for Greece.
Greek government debt prices went from peak to bottom in the February-March period as enthusiasm about fresh credit rating upgrades, the big cash reserves, a pick-up in GDP growth and large primary surpluses gave rise to anxiety as the global Covid-19 pandemic came knocking on Greece’s door.
The situation deteriorated when the European heads of state failed to agree to coordinate their fiscal policies and the president of the European Central Bank (ECB), Christine Lagarde, said it is not the ECB’s job to “close the spread” between the bonds of different member states. Essentially, Lagarde appeared to undermine the 2012 guarantee given by her predecessor, Mario Draghi, to do ‘whatever it takes’ to preserve the euro.
Another eurozone crisis
A number of market participants combined the two stances together and concluded that the probability of another Eurozone crisis had arisen. Greek along with Italian and other countries’ bonds were sold off and their yields soared by a record daily amount, pointing to acute systematic risk. Despite some backpedalling in public by the ECB president, sovereign yields continued their march upwards.
The Greek 10-year bond yield began that week at 2.10 percent and traded as high as 4.09 percent on Wednesday, March 18. It had fallen to as low as 0.96 percent on February 21. The Italian 10 year yield began that week at 1.85 percent and spiked at 2.99 percent in panicked Wednesday trading. Two weeks ago, Italy could borrow for a decade at just 1.0 percent.
It was the last thing governments in Athens and especially in Rome needed as they considered beefing up public spending to contain the pandemic crisis.
Elsewhere, Portuguese yields stood at 0.86 percent in early-Monday trading before spiking at 1.61 percent by mid-week, while Spanish yields surged from 0.66 percent to 1.38 percent. Even German 10-year bund yields rose from Monday’s negative 0.59 percent to Wednesday’s negative 0.24 percent.
Government officials in Athens were particularly concerned for two reasons. Firstly, the country’s borrowing costs went up sharply, and more importantly, secondly, the Greek yield curve flattened around 4.0 percent, meaning short-to-medium term yields rose to almost the same level as 10-and 15-year bond yields.
“The market was sending the message that the economy was moving into recession and it expected a credit event,” said a high-level official who was closely monitoring the situation.
A great risk to Greece
According to a government source, Prime Minister Kyriakos Mitsotakis was aware the ECB was contemplating a new bond buying program (QE) and sought the eligibility of Greek bonds for the scheme. Mitsotakis reportedly conveyed the message to the ECB’s Christine Lagarde that the spike in yields and the flattening of the Greek yield curve posed a great risk to Greece, which had adopted restrictive economic policies and played by the book for several years.
He stressed the country was going to be hit hard by the global coronavirus pandemic which was not of its own making. Therefore, keeping Greece out of the new QE would amount to discrimination in the face of a global pandemic risk. It would have equated to the ECB treating Greece as a non-euro country, he reportedly told Lagarde, according to the source.
Although the Greek arguments were sound, there were some voices at the ECB suggesting the country did not meet the criteria, such as having at least one investment grade credit rating from a major rating agency and its debt essentially being deemed sustainable by the ECB. The same officials reportedly suggested Greece could make use of its 32 billion euro cash reserves while local banks could seek extra liquidity through the central bank’s ELA (Emergency Liquidity Assistance) mechanism.
Greece had also tried to be included in the European Central Bank’s asset purchase program, widely known as quantitative easing, when it exited the third economic program in August 2018, but failed.
However, this time was different. Under pressure to act to bring down borrowing costs for indebted, virus-stricken countries such as Italy, the ECB launched a new, 750 billion euro emergency bond purchase scheme worth 6.0 percent of the euro area’s GDP, and Greece was unanimously in.
“Extraordinary times require extraordinary action,” ECB President Christine Lagarde said after an emergency policy meeting. Greek Finance Minister Christos Staikouras described the decision as “Practicable support for the country... and an indication of confidence in the government’s maneuvers.”
In approving the new Pandemic Emergency Purchase Program (PEPP), the ECB’s Governing Council stated “a waiver of the eligibility requirements for securities issued by the Greek government will be granted for purchases under PEPP...
For the purchases of public sector securities, the benchmark allocation across jurisdictions will continue to be the capital key of the national central banks. At the same time, purchases under the new PEPP will be conducted in a flexible manner. This allows for fluctuations in the distribution of purchase flows over time, across asset classes and among jurisdictions.”
Greece’s capital key is just above 2.0 percent of marketable debt. Excluding bonds held by the eurosystem, holdouts and PSI bonds, the ECB could buy up to an estimated 12 billion euro in Greek government bonds through the new bond buying program (PEPP). It amounts to the average daily turnover of about 40 trading sessions in Greek bond trading in the last few months.
The ECB’s decision translated into a spectacular rebound for Greek bonds the next day. The yield of the benchmark 10-year bond dropped by more than 200 basis points, hovering close to 2.0 percent, halved from the 4-percent range just one day earlier. Other bond yields retreated fast in a spectacular fashion and the Greek yield curve became upward sloping, erasing the probability of a credit event.
Of course, Greek yields have yet to come down close to their historic low levels reached last February. However, it is very important for Greece to be able to borrow at relatively low rates to fund its increasing borrowing needs as budget spending to fight the Covid-19 pandemic keeps increasing. The QE helps substantially in that respect.