How far unsolved repayment of Greece's debt lead? Straight to the abyss

A joint EU’s and IMF’s financial support similarly imposed even higher burden to Greece. A €110 billion EU/IMF bail-out package approved in May, 2010 followed by the Eurozone’s €12 billion bail-out package in June, 2011 and extra €109 billion support in July, 2011 were agreed in exchange of accepted severe austerity measures those involved spending cuts, tax increases and privatization of public assets. Passed proposed measures without taking a recovery plan into consideration shrank Greece's economy into deeper recession.


According to the remarks mentioned at the IMF’s conference called on Greece in December 13, 2011, the representatives of the mission revised the Greece’s GDP growth down to -6% in 2011, and -3% in 2012. So, could anything worse be expected than deteriorated Greece's economy and increased Greek default probability?

Credit Default Swaps were invented by Wall Street as credit insurance to reduce risks and facilitate issuance of debt securities. However, it may appear that banks, investment banks or hedge funds those issued the Greek Treasury CDS do not have enough collateral to compensate the insured for his loss if Greece default on its debt. If the above is possible then a voluntary private sector involvement in 50% nominal haircut proposed in October 2011 may also be treated as an agreement designed to avoid the collapse of insurers. It is expected that voluntary accepted write-down of Greek debt will not trigger CDS compensation and at the same time will reduce the Greece's sovereign debt by €100 billion. An extra €100 billion support to Greece could reduce its debt to 120 % of GDP till 2020.

However, the success of such agreement which is aimed to minimize losses depends on the proportion of Greek bonds holdings and issued CDS. According to the information published at the New York Times in January 10, 2012, it was estimated that a few months ago about €200 billion of Greek bonds were held at large European banks. But as talks have dragged on, many big holders in France and Germany sold their holdings to London Hedge Funds and other independent investors. Hence, a voluntary private sector agreement to accept a 50% haircut may be harder to achieve if an entity which possess Greek bonds is not an issuer of the CDS.
On the other hand, if an agreement of a voluntary 50% haircut is available then what a purpose and a future of the credit default swaps? According to the BIS quarterly review issued in December, 2011, a notional amount of outstanding credit default swaps was $32.4 trillion in June, 2011 with a gross market value of $1.35 trillion.

What bilateral agreements do markets accept?

Germany sold 4.06 billion euros of the bonds on the 4th of January with the average yield of 1.93% on 10 year government bonds. France sold 7.9 billion euros of bonds on the 5th of January with the average yield of 3.29% on 10 year government bonds. It is supposed that Italy’s and Spain’s borrowing in the markets this week could be facilitated as well due to the ECB’s injected liquidity through 3-year refinancing operation worth of 500 billion euros and expectations that the ECB’s Governing Council will cut interest rates on the January 12 meeting. However, despite the European sovereign debt crisis and broken markets’ confidence, China, Japan and South Korea move forward to closer financial cooperation.


After the Asian financial crisis in 1997-98, the leaders of East Asian Countries agreed to promote the Chiang Mai Initiative (CMI) which aimed to create a network of bilateral swap arrangements (BSAs) among ASEAN+3 countries to tackle short-term liquidity issues and to supplement the existing international financial arrangements.

Under the above mentioned initiative, the $120 billion crisis fund was established. In 2001 Finance ministers of ASEAN+3 agreed to exchange data on capital flows bilaterally on a voluntary basis in order the effective policy dialogue was facilitated and in 2005 Finance ministers agreed to enhance the effectiveness of the CMI by (1) integrating and enhancing the ASEAN+3 economic surveillance into the CMI framework, (2) clearly defining the swap activation process and the adoption of a collective decision-making mechanism, (3) significantly increasing the size of swaps, and (4) improving the drawdown mechanism. Moreover, developed bond markets under the same initiative reduced the dependence on short-term foreign currency-denominated financing and helped to mitigate the vulnerability caused by the currency and maturity mismatches aroused due to the volatile short term capital movements.

Japanese Prime Minister Yoshihiko Noda visited the Chinese Premier Wen Jiobao on the 25th of December in 2011 and discussed a bilateral package of financial agreements. According to the Bloomberg, Japanese government-backed entity will sell yuan-denominated bonds in China to deepen China’s domestic capital markets and other measures will be applied to facilitate the trade among Chinese and Japanese companies in their domestic currencies. These actions should reduce trade costs as measures are designed to eliminate the usage of the US dollars in exchange of currencies. Moreover, those agreements will ease the entrenchment of the Chinese yuan as a reserve currency.

However, China’s one-way determined exchange rate’s policy puzzles the most. If Japan, South Korea, US, European and other trade partners decide to set the domestic currencies and China’s yuan exchange rates then who will be right.