Varoufakis plan not going anywhere

the markets got a boost after Yanis Varoufakis announced the Greek plan not to go for a haircut but for a debt swap instead; Greek shares rose 11%, 3y Greek bond yields fell 3.5pp and even 10y government bond yields fell 1pp; official reactions were more sceptical; the FT cites ECB sources saying there will be no rise in the T-bill ceiling, as the Greek government had requested an additional €10bn; without a T-bill deal, the Greek government will be strapped for cash and out of time to negotiate a new deal; Jean-Claude Juncker is expected to ask Alexis Tsipras today for a “technical” extension of the current bailout, already ruled out by Yannis Varoufakis earlier; Varoufakis' debt-swap plan is to be discussed at a Eurogroup emergency meeting February 11; Greece’s primary surplus for January was €1.3bn; the IMF says the troika cannot be abandoned easily; the USA intends to send a mediator mission with debt crisis experts to help broker a compromise deal between Greece and its creditors; Further News the German reaction to Varoufakis' swap is currently very negative; Bild accuses the Greek government proposal of a clandestine plot, and reminds its readers that this is a debt restructuring by another name; Frankfurter Allgemeine has the story that the Greeks are proposing a debt-to-equity swap under which the bank restructuring loans are switched into equity; also nobody there believes that the Greek whirlwind tours will bring much; Matteo Renzi met with Tsipras in Rome - Renzi is sympathetic to Tsipras, but keen not to be seen as part of anti-German alliance; Zsolt Darvas argues a debt swap is a fantastic idea - moreover it can constructed producing no change in the net present value - so it becomes a pure insurance product; Paolo Mauro argues that proponents of a debt swap will need to answer a number of issues from the critics, including how this will affect incentives to cheat with the national accounting; we think that a debt swap is great in principle, but unlikely to be visible to a Syriza supporter, and unlikely to make a big deal of difference to the Greek economy; Producer prices fell by 1% mom during December, and even the core rate was negative - prices are essentially stagnant for over three years now.

The blogosphere is gung-ho about the Varoufakis plan. The official reaction is more sceptical. As of this morning, it does not appear that this will fly.  Peter Spiegel managed to answer one of the two questions everybody has been asking: what the ECB will say about the Varoufakis plan. He quotes two officials involved in the deliberations saying that the ECB will not raise a €15bn ceiling on T-bill issuance to $25bn as requested by Athens. Yanis Varoufakis had proposed to increase the ceiling by €10bn as a bridge financing for the next three months to allow for a new agreement to be negotiated. But the ECB is unwilling to approve the debt sale, says the article. The ECB’s stance raises the stakes in the stand-off, and is also likely to bring some sense of realism to the markets, where the optimistic reception to Varoufakis' plan lifted the stock market in Athens, bank shares in particular, and reduced the 10y borrowing costs by a full percentage point while the 3-year bond yield was slashed by 3.5pp to 16.42% and the 5-year yield decreased by 2.5 pp to 13.04%. There are also first reactions from Germany and Italy (see below), and we expect more to follow through the next days. Jean-Claude Juncker is expected to press Alexis Tsipras to ask for a “technical” extension of the current bailout when the two men meet in Brussels on Wednesday though Varoufakis had ruled this out already. The Greek finance minister is due to meet Mario Draghi in Frankfurt on Wednesday and Wolfgang Schäuble on Thursday. Varoufakis’ plans will be discussed by Eurozone finance ministers in an emergency meeting in Brussels on February 11. The Greek government had indicated earlier that it can last until June without additional support. Macropolis writes that the primary surplus for January was €1.3bn (revenues €4.8bn and expenditures €3.3bn), local media reports a €2bn cash reserve and another €2bn that could be raised. Another potential source of short-term cash being sought by Mr Varoufakis is €1.9bn in profits the ECB and eurozone central banks earned by holding Greek bonds to maturity. Under a deal agreed in 2012, that cash was to be returned to Athens, but has not been. The FT article says eurozone ministers are unlikely to allow those funds to be released without conditions. Also of concern is the access of the Greek banks to funding. Apart from deposits, Greek banks have EFSF bonds of around €37bn, while the €21bn in collateral that becomes ineligible for ECB liquidity after February 28 can be placed with the BoG ELA, if this were to be granted, albeit at a higher cost of 1.55% compared to 0.05% for the ECB, writes Macropolis. And what will happen with the rollover of 3- and 6-month T-Bills worth €2.4bn, which are due on February 4 and 11 respectively?  There is also a dampening of expectations from IMF officials, saying that the troika cannot easily be abolished, according to Greek Reporter. Tsipras might meet with Christine Lagarde, but she is not in charge of the Greek programme, they say, and there are other procedures in the IMF. The USA, meanwhile, is considering sending over a mediation mission of government officials with debt crisis experience, to help finding a compromise between Greece and its international creditors. The German media really hate this swap There has been no official or even unofficial reaction from Germany. Angela Merkel said she would not comment on everything. Schäuble will not say anything until he meets with Varoufakis on Thursday. The German papers and websites by and large missed the story yesterday, but caught up this morning with a vengeance, realising just how much they hate the whole idea. The reaction from Bild is usually a good bellwether. The headline reads: "This is how the Greeks want to cheat on their debts." The paper noted that the Greeks are not talking about a haircut but only because the Germans don't like the word. So Varoufakis is choosing another word. The article quoted him as saying that his government would do anything to free the country from the debt-serfdom, and is ready to use euphemisms to achieve that.  Frankfurter Allgemeine notes that Varoufakis has not yet found a single ally for his debt restructuring plans. The paper gives an important additional detail of the Varoufakis plan (in the last paragraph of the article). It says the plan is to swap the entire bank restructuring loans by the EFSF, a total €41bn, for equity in the Greek banks. Berlin is apparently outraged by the idea, since the banks are worth only €8bn. The paper quotes diplomats as saying that envisaged meetings between Tsipras and Francois Hollande and Jean-Claude Juncker are unlikely to produce anything concrete. It noted that several eurozone member states have lower per capita income than Greece - the Baltics - and they have nevertheless contributed to the Greek programme. They will not accept a haircut. The paper also noted that a shift in the primary balance from 4-4.5% to 1-1.5% would change the entire debt reduction trajectory fundamentally. Tsipras and Varoufakis continue their whirlwind tour of European capitals. Yesterday, they were both in Rome. There was no press conferece after the meeting between Varoufakis and Pier Carlo Padoan, and mostly fluff in the public appearance by Tsipras and Renzi. La Repubblica writes that Renzi is cautious about Tsipras. He sees him as a useful ally in his own quest to soften the deficit rules. But Renzi is also cautious, and clearly not ready to isolate Germany. This does not look like a Renzi-Tsipras alliance. The article said that Padoan is also cautious. They want to wait until the plans become more concrete, and until the Varoufakis-Schäuble meeting. The diplomacy is mindbogglingly complicated - and they are not good at this. Without co-opting the Germans into this plan - or at least the SPD - this is not going to fly. Darvas on what a compromise could look like We, too, like the idea of a GDP-linked debt in principle because this avoids a lot of the debt-procyclicality. What we fail to see is how we are going to get from here to there. What we also fail to see in particular, is anything that would actually solve the problem. For today, we are focusing on commentaries from two think tanks.  We noted a number of commentators, who are mostly full of praise for Varoufakis. Zsolt Darvas from Bruegel gives an extremely upbeat assessment, and sees the eurozone now on a path towards a resolution of the Greek debt crisis. He said it was important that Syriza formally abandoned the demand for a debt write-off - which he said would be unnecessary anyway, citing the usual arguments which we will not repeat. Darvas wants the €141.8bn EFSF and €52.9bn bilateral loans indexed to GDP in a neutral way, so that it will not lead to a fall in NPV. The ECB problem is solved by Greece accepting another ESM loan to pay off the ECB, which obviously would come with some conditionality attached. That might be a political problem for Syriza. He said one could go further, and keep Greece out of the market until 2030 (as opposed 2022). One could add another ESM loan to pay off the IMF. which would yield additional i/r savings. On the primary balance, Darvas suggests a compromise between the current 4.5% and Varoufakis' 1-1.5%. The question is why should the eurozone offer Greece such a deal. He says there is a moral obligation because the lenders mis-designed the programs, and underestimating the impact on GDP and employment. And most importantly, Grexit would be a catastrophe for Greek, and a huge risk for the eurozone.  Paolo Mauro from the Peterson Institute focuses on the debate the eurozone is likely to have, by listing the counter-arguments the Varoufakis proposal will have to address. A government-to-government state contingent debt instrument is quite rare. He lists the Anglo-American financial agreement of 1946, which had a waiver on i/r payment when the UK forex income was insufficient. It would be morally harder to make the case for Greece, given that the debt crisis is predominately the fault of domestic policies in Greece. But for the scheme to work, Greece has to earn the trust of European taxpayers by guaranteeing the quality of its economic statistics and the independence of its statistical agency from political interference. The second argument is that a debt clause gives rise to moral hazard - there is no incentive to grow, and to pursue structural reforms. The third argument is even more mundane. Greece might fiddle the GDP data - something that happened in Brazil in the 1980s. He says European leaders should be sympathetic, but be open to negotiate a mutually beneficial compromise. And the Greeks need to find a way to reassure everybody that statistics are sacrosanct. On Darvas: The eurozone may well agree this in the end - but this would be a very weak agreement. A primary deficit at 2.5-3% would still be far too high. We think that Varoufakis' 1-1.5% is actually appropriate, rather than a negotiating position. A debt swap without NPV effect protects against future shocks - but the main shock already happened, there is no retrograde insurance. Such a debt swap is more interesting in theory, than in practice. If Syriza accepts this the Greeks would then have to vote for an even more radical political party to get some noticeable real-world policy change, because this one would be invisible to them. Our key argument is this: if you believe that the Greek programme landed the country in a toxic debt-deflation that has rendered the economy forever weak in the absence of a regime change, you would need a significant regime change to bring about sustainability. If this is what's on offer, it would be more rational for the Greeks to default unilaterally. Deeper and deeper into deflation Last Friday's inflation numbers were not good. We are particularly concerned about the 0.5% core inflation rate. Yesterday came the producer prices for December, not looking good for headline and core rates. Industrial producer prices were down 1% mom during December. The yoy rate was -2.7%. The biggest component of the monthly rate were the volatile energy costs. But the core producer price rate is also in deflation at -0.2% mom. That number has nothing to do with energy costs. The core rate has essentially been flat since the beginning of 2012. We are well into the long-run of inflation expectations having come unstuck. See this Eurostat graph below - the pink line is the core rate. The headline rate is the bright red one. Ignore the dotted lines. Eurozone financial data 10y spreads Previous day Yesterday This Morning France 0.235 0.232 0.239 Italy 1.313 1.244 1.235 Spain 1.173 1.131 1.123 Portugal 2.157 2.037 2.000 Greece 11.054 9.463 9.84 Ireland 0.850 0.828 0.809 Belgium 0.296 0.286 0.291 Bund Yield 0.317 0.348 0.357 exchange rates Previous This morning Dollar 1.134 0 Yen 133.010 134.78 Pound 0.755 0.7568 Swiss Franc 1.049 1.061 ZC Inflation Swaps previous last close 1 yr -0.46815 -0.385 2 yr 0.05065 0.105 5 yr 0.715625 0.75125 10 yr 1.140625 1.1775 Eonia 02-Feb-15 -0.02 30-Jan-15 0.09 29-Jan-15 -0.03 28-Jan-15 -0.03 OIS yield curve 1W -0.025 15M -0.102 2W 0.003 18M -0.104 3W -0.030 21M -0.105 1M -0.012 2Y -0.097 2M -0.012 3Y -0.062 3M -0.019 4Y -0.014 4M -0.057 5Y 0.045 5M -0.059 6Y 0.120 6M -0.067 7Y 0.202 7M -0.078 8Y 0.286 8M -0.075 9Y 0.370 9M -0.073 10Y 0.449 10M -0.076 15Y 0.718 11M -0.078 20Y 0.887 1Y -0.082 30Y 1.030 Euribor-OIS Spread previous last close 1 Week -0.071 -0.871 1 Month 2.571 0.771 3 Months 4.786 4.686 1 Year 31.929 33.169 Source: Reuters To unsubscribe click here