Analysis-Greek bonds snapping at heels of southern Europe's best in class

By Stefano Rebaudo

(Reuters) – Greece is heading into an election weekend with its public debt trading near the levels enjoyed by first-class peripheral countries, a decade after a debt crisis forced a dramatic reshaping of its borrowing.

The premium investors demand to hold Greek debt instead of that of top-ranked peripheral countries such as Spain is narrowing and could even vanish completely as its debt profile has improved and its economy enjoys the support of European funds for years to come.

At the end of the crisis, Greece’s private sector was completely under-leveraged, with one of the lowest loan-to-deposit ratios among advanced economies and a deep investment gap compared with the rest of the euro area, Bank of America (NYSE:) said recently.

Furthermore, almost 80% of central government debt is in the hands of the official sector, with a weighted average maturity of close to 20 years and stable servicing costs.

The country has received three international bailouts from the euro zone and the IMF worth 280 billion euros ($308 billion) since 2010. It emerged from its latest bailout programme in August 2018, and has since relied on the debt markets to cover its borrowing needs.

“All these factors justify a narrower spread, or no spread at all (versus Spain),” said Athanasios Vamvakidis, global head of G10 forex strategy at BofA.

“The Greek (bond) market is not so liquid and tends to be more volatile, but we have a lot of good news. We cannot say prices are fictitious,” he added.

The Greek economy is still heavily exposed to volatile sectors like tourism or shipping, but it is less sensitive to manufacturing headwinds.

Political stability is also crucial. Under a new electoral system, the winner of the June 25 vote can receive bonus seats, so if New Democracy led by Greece’s conservative leader Kyriakos Mitsotakis broadly repeats its May performance, it will likely secure a clear majority.

The premium, or spread, of Greek government bond yields over those of Spain recently fell to its lowest since 2008 at around 27 basis points. Across southern Europe, only Portugal and Spain trade at a smaller premium to Germany – the euro zone benchmark – than Greece.

Analysts think peripheral spreads generally could widen, as those bond prices have rallied recently. But the medium-term outlook for Greece is still positive.

Goldman Sachs (NYSE:) expects Greece’s debt-to-GDP ratio to fall by 10 percentage points a year and to drop below Italy’s in 2026 as they forecast a small Greek primary balance surplus coupled with strong economic growth.

It says that even in its worst-case scenario, which includes an economic contraction of around 1 percentage point, or a widening of 100 basis points in the yield spread over Germany would not blow Greece too badly off course in terms of bringing down the debt ratio.

By the end of this year, Greece’s debt-to-GDP ratio is expected to fall to around 160% while Italy’s is seen at 142%, according to official estimates.

“The combination of low sensitivity to policy rates, thanks to financial assistance programmes still in place, and the investment boost of the European Recovery Fund (about 3% of GDP yearly) provide unprecedented support for the Greek economy,” said Filippo Taddei, European economist at Goldman Sachs.

The gap between Italy’s and Greece’s spreads over Germany hit zero in November 2019, but it widened significantly after the May election in Greece.

“The key to why the Greek yield spread is lower than Italy’s is because Greece basically does not have any refinancing needs in the coming 10 years due to the measures taken 10 years ago during the sovereign debt crisis,” said Piet Haines Christiansen, director of fixed income research at Danske Bank.

Italy’s Prime Minister Giorgia Meloni has presented herself as a good European citizen, sticking to former prime minister and former ECB boss Mario Draghi’s reform agenda.

“However, this credit may be wearing thin as the government refuses to sign up to ESM reform and struggles to unlock NGEU funds,” said Christoph Rieger, head of rates research at Commerzbank (ETR:), referring to the EU support funds.

Italy is the only country dragging its feet over approving the treaty that reviews the so-called European Stability Mechanism (ESM) due to concerns it could trigger a restructuring of Italy’s own public debt.

Ratifying the reform of the euro zone bailout fund could nevertheless boost the credit standing of the European Union’s most indebted countries, an Italian Treasury document seen by Reuters showed on Wednesday.

($1=0.9104 euros)

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