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It’s summer, the Sun is high in the sky… and the European sovereign stress is low.
But that hasn’t stopped Barclays Capital looking for glimpses in the crystal ball.
As they noted on Friday, the European Financial Stability Facility’s mere existence has started to feed liquidity back into sovereigns’ refinancing, without them actually having to activate it. There are plenty of other factors of course, such as the market for government debt getting over a hump in summer supply, for one thing.
That hasn’t solved the question of eventual eurozone defaults, however:
By backstopping sovereign liquidity, the EFSF took the possibility of a market-driven default off the table. Any sovereign default will therefore be strategic, but the motivation to pursue this path will not exist for several years, in our view, because a restructuring/default would likely entail a loss of access to capital markets. When deficits are largely interest burden and/or cyclical in nature, this is not necessarily very painful.
At the time of Argentina's default, for example, the government was running a deficit of 6% of GDP, of which roughly 5% was interest expense. But this is not the case for European governments today: their deficits are structural not cyclical, and they result from government expenditure exceeding tax revenue, rather than interest burden. A default would entail loss of capital market access and an instantaneous closure of these deficits, necessitating a severe reduction in government spending. We believe governments will seek to avoid this outcome, at least until primary government deficits are reduced.
It’s an interesting, and ironic, argument — getting through all this fiscal austerity will eventually just make it much easier for sovereigns to default. If they’re so inclined.
And we can see one sovereign whose combination of a high primary deficit and a high interest balance might make that attractive — as shown in the chart below:
Although a Greek exit has been priced in by now, Barcap reckon. Well, who knows what the future holds?
Related links: Spain is caught up in self-delusion – FT Greece: A marathon to sprint – FT
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