Friday, May 27, 2011

The 21 Countries Most Likely to Default

The Atlantic ran a short piece that listed the 21 countries it felt were most likely to default based on the price of Credit Default Swaps (CDS). Why 21?  The published list is in a rather annoying click through format so it is reproduced here.  The numbers give the price of 5-year CDS in basis points.

  1. *Greece, 1393.33
  2. Venezuela, 1026.92
  3. *Portugal, 663.67
  4. *Ireland, 662.83
  5. Argentina, 612.77
  6. Ukraine, 450.02
  7. Lebanon, 359.35
  8. Vietnam, 305.45
  9. *Spain, 275.67
  10. Croatia, 264.83
  11. Hungary, 260.00
  12. Romania, 230.17
  13. Bulgaria ,203.50
  14. Lithuania, 201.50
  15. *Italy, 167.88
  16. Turkey, 164.21
  17. *Belgium, 156.88
  18. Kazakhstan, 151.52
  19. Israel, 147.98
  20. Poland, 140.32
  21. Russia, 136.83

The list is dominated by European countries (in bold) and has six eurozone countries (asterisk).  You may not be able to access CDS markets but maybe you could make some money on this very thin market provided by Intrade.  I would not buy this contract at any price above 5 for 2011.  If a 2013 contract was available the price would have to be below 25.

Unlike the view coming from the CDS market I am not of the opinion that “default is inevitable”.  We are going to need a lot of help, almost all from the EU/IMF package, and a reduced interest rate, an extended repayment schedule , and access to the €15 billion of the €35 billion set aside for the banks that will not be used will be necessary.  If this unused €15 billion could be added to the €50 billion already committed to funding the State then a re-entry to bond markets in mid-2013 would not be required.

At this remove it is impossible to see how we could obtain sustainable interest rates from bond markets.  The 10-year yield on the secondary market is over 11%.

Bond Yields 3M to 27-05-11

The drop in yields that followed the bank stress tests that revealed that €20 billion of the €35 billion contingency fund would be used to recapitalise the banks was short lived.  Yields quickly returned to 10% and have now broken through the 11% barrier.  We could not sustainably borrow money at these rates.

As Prof. Karl Whelan has usefully pointed out the current €50 billion package and the use of our existing cash resources would probably get us towards the end of 2013.  Prof. Whelan concludes:

My conclusions on this are that even an optimistic scenario sees the state requiring additional funding of €11.7 billion over and above the EU-IMF money to finance the state for the next few years. With cash balances apparently dwindling to about €7 billion in a couple of months time, it seems that we may soon be faced with the prospect of either an intensification of fiscal adjustment in an attempt to reduce deficits to fit the size of our funding or else a return to the markets some time during 2013 with no margin for error. An alternative prospect would be to attempt to negotiate a new EU-IMF deal next year that would allow the state to defer a return to the markets.

Going into 2014 we would still have a large, but hopefully declining, annual deficit to fund and on the 15th January we have €11.9 billion of bonds maturing.  After that we do not have any bonds maturing until April 2016.  At 12.97% these bonds had the highest yield of all Irish governments bonds in today’s trading.

If the €15 billion earmarked for the banks could be transferred to the State it would delay the necessity to return to the markets until the middle of 2014.  This is also reported here.  It is probably a little incorrect to say that there is €15 billion of EU/IMF money that will go unused.  Of the original €35 billion contingency fund for the banks €17.5 billion was coming from the EU/IMF and €17.5 billion was coming from our own resources - €10 billion from the NPRF and €7.5 billion from our cash balances.

Now that the final bank recapitalisation will require €20 billion we know it will be €10 billion from the NPRF and €10 from the EU/IMF package.  The €15 billion that is unused is €7.5 billion of our own cash we obviously still have access to and €7.5 billion of EU/IMF money which we are no longer using.  So the actual change to the EU/IMF deal would require €7.5 billion of money to be allocated to funding the State rather than the banks.

If we could get to the middle of 2014 we would be two years from having to rollover any of our existing debt and the requirement for new debt would be substantially reduced, provided we have brought the deficit under control.  At the most we may need to borrow an additional €4 or €5 billion in 2014 if the full €15 billion could be redirected.

I do not think the threat of default is as clear as the above table would indicate.  However, if we are to avoid that in 2014 we do need access to around €20 billion of funding.  It is very hard to imagine that we will be able to obtain that from bond markets.  If we cannot access the funds the outcome will be a default.  This is the outcome that those trying to resolve this crisis are trying to avoid.  In my view there is the capacity to do.

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