According to Bloomberg, Greece’s 2-year bond continues to rout, and now yields 15.07%. The 10-year is moving in the same direction, now yielding 9.76%. Remember, even at previously lower yields, Greece looked set on the path for default:
‘[Before:] In order for Greece to simply stop increasing its total outstanding debt, it thus has to achieve a primary budget surplus of about 7.44% if interest payments are not to push the budget into deficit, according to Mr. Münchau. This is assuming the economy doesn’t grow. If the economy can manage 2% growth, then Greece needs a 4.96% budget surplus just to tread water.”
The above analysis, originally from Eurointelligence, used the simple yet effective ‘debt sustainability rule’ to calculate what budget surplus is necessary to keep the total national debt from growing, based on interest rates and GDP growth.
It is calculated as “the break-even primary balance (PB) requires a country to sustain the debt-to-GDP ratio (b), with marginal interest on future bond issues (i) and the rate of nominal growth (g): PB = b*(i-g).” In Greece’s case a recent value for debt-to-GDP (b) is 123%.
But… it was based on the older, lower bond yields. Now things are even worse. If we plug the latest 9.76% 10-year bond yield into the equation, we get the following. (Note we aren’t even plugging in Greece’s 2-year yield, assuming the country would borrow for 10 years instead to fund itself. It works for our purposes, this is a back of the envelope)
This table shows that even with strong 4% GDP growth, Greece would need to achieve a huge 7.08% budget surplus just to keep its debt to GDP ratio from rising further. Too bad Greece’s economy is expected to contract this year, rather than grow, and it has a budget deficit, rather than a surplus!
Thus the latest spike in yields means Greece is truly a goner. Note this is even with the planned IMF 45 billion euro bailout. Markets know the bailout is coming yet are still pushing yields higher.
The maths above makes it clear. Debt/GDP will likely rise rapidly this year due to a shrinking economy and a huge budget deficit. As debt/GDP rises, it only makes the equation above even uglier — It becomes harder and harder to dig yourself out of the hole.
This is the debt trap in action.
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