Berlin likely to back down on Greek aid

GERMANY will probably back down in its battle with the European Central Bank over a new aid package for Greece rather than risk a breakup of the euro, said Andrew Bosomworth, a fund manager at Pacific Investment Management.

“I think in this case, Germany probably is going to come down, to back off,” Mr Bosomworth said in an interview with Deirdre Bolton on Bloomberg Television’s InsideTrack. “If it doesn’t and really insists and it sticks to its ground, then we are going to have something that looks like the early 1990s when the pound sterling and the Italian lira went out of the exchange-rate mechanism.”

While a euro breakup wasn’t part of his “base-case” scenario, Mr Bosomworth said chances were above five on scale of one to 10 that it could eventually happen if Germany doesn’t back down.

ECB policymakers have warned against German proposals that maturities on Greek debt be extended for seven years, an outcome rating companies have said would be considered a default event.

ECB President Jean-Claude Trichet said on June 9 that governments were flirting with an “enormous mistake”.

Mr Bosomworth said Germany will probably compromise and accept a plan being put forward by other European Union countries for bondholders to agree to roll over their debt voluntarily, an approach that Trichet indicated may be acceptable to the ECB, the biggest holder of Greek bonds. The approach is modelled on the Vienna initiative, where banks agreed to roll over loans to units in eastern Europe at the height of the financial crisis in 2009.

“I think it’s going to be a resolution in the form of a very forceful Vienna II agreement, whereby the private sector will voluntarily commit to roll their debt with a lot of encouragement from their government,” he said.

A year after its €110 billion bailout, Greece remains shut out of financial markets, with its 10-year bond yielding a euro-era record 17.87%. EU and International Monetary Fund officials are scrambling to cobble together a new aid package to cover a funding gap of about €30bn next year, when the original plan envisioned Greece returning to the financial market.

A voluntary rollover may avoid triggering credit default swaps on Greek debt, though credit-rating companies have greeted the proposal with scepticism.

Fitch Ratings reiterated that it would probably deem Greece in default under such an approach.

Fitch said that any rollover done to avoid a default would by definition be coercive, not voluntary, and the new bonds would likely be “materially less advantageous” to investors.

“A debt exchange or similar mechanism that offers new securities with terms that are — on the whole — worse than the original contractual terms of the existing debt and where the sovereign is subject to financial distress, which can be reflected in low issuer ratings, or ratings which have seen a sharp downward migration, or both would be judged by Fitch to constitute a distressed debt exchange and hence a default event, even if bondholders’ participation was deemed to be voluntary,” Fitch said.