On July 21, EU leaders, the European Central Bank and the International Monetary Fund agreed on a second rescue package for Greece, one they hoped would put the country in a position to come to grips with its debts. As they agreed, fears were already growing over Spain and Italy, which a few weeks later required the ECB to step into the market and start buying the bonds of both countries.
While the ECB intervention pushed borrowing costs lower for Italy and Spain, the euro zone’s third- and fourth-largest economies, that deal for Greece is now looking like it could fall apart.
Yields on 2- and 10-year Greek debt stand at 47 and 18 percent, respectively, and the debt swap agreed to on July 21, which required private investors to agree to accept longer-dated bonds than they had purchased, is not going well. On Friday, the Greek government indicated it would walk away from the debt swap unless it got 90 percent sign-up from private investors. So far, less than 60 percent are thought to have done so.
If the deal collapses, then a new support mechanism will be needed. “The financing gap in this case will have to be covered by official financing, probably by the European Financial Stability Fund,” Athanasios Vamvakidis, the head of G10 FX Strategy at Bank of America Merrill Lynch, said on Friday.
So borrowing costs are soaring and the debt swap deal is looking shaky at best, but the problems do not end there. Next up are the terms under which other euro zone members will lend money to Greece. Finland has demanded collateral from Greece before it lends money, and others, like the Netherlands, Slovenia, Slovakia and Austria, say they will want the same deal if Finland gets its way.
Germany, which would have to lend the most money to Greece, has said Greece can't be forced to offer up collateral. Finland is thought to want collateral worth 20 percent of any loan.
“If all five economies gained the same deal that Finland has reportedly agreed, Greece might have to set aside up to 13 billion euros of its new 109 billion euro loan package as collateral,” Ben May, a European economist at Capital Economics said in a research note.
There could be a few ways to fudge the issue, according to May, including lending more money to Greece in order to cover the need for collateral or demanding actual assets as collateral. He does, however, see a problem in the fact that 10 percent of Greece’s outstanding debt is reported to contain a so-called "negative debt clause" which requires governments not to pledge any assets against their borrowing.
“Accordingly, by providing Finland or anyone else with collateral, Greece would effectively be defaulting on these bonds,” he said.
“Unless Finland gains an alternative sweetener, it could withdraw its guarantee altogether. Given the stance of the Netherlands, Austria, Slovakia and Slovenia, there is a risk that these economies could threaten to do the same, prompting the rescue package to collapse," May said.
In an interview with Finnish daily Helsingin Sanomat on Saturday, the country's prime minister, Jyrki Katainen, said "This matter has to be solved as soon as possible so Finland's aims will not hurt other countries.”
There is time to find a solution, given that the first bailout for Greece means the country does not need to raise new money until 2012. The entire crisis does, however, highlight the inability of the EU to find a solution for one of its smaller members.
“If many European policymakers are unwilling to provide Greece with uncollateralised loans worth around 1 percent of euro-zone GDP, they appear unlikely to sanction support for the likes of Italy and Spain, should they eventually require it,” said May .
The next problem is growth, or the lack of it. Under the terms of the EU/IMF bailout, Greece must cut its budget deficit to 7.6 percent of gross domestic product, but with the economy contracting and tax revenue missing expectations as a result, this is proving extremely difficult. Evangelos Venizelos, the Greek Finance Minister, admitted on Friday that the economy would contract by 5.6 percent this year, versus an earlier forecast of a 3.9 percent contraction.
Venizelos also said that his government was “very close” to meeting its targets, but this may not be good enough for the IMF, which this week will engage the Greeks in talks that will reportedly be “tough.”
A source close to the talks told Reuters on Friday that "Not meeting the targets will trigger very difficult negotiations. It will not be easy next week."