Instable equilibrium to persist

LONDON: The much respected former chief economist of the ECB said last week that Greece is "not just illiquid, it is insolvent". Talk of a soft restructuring and suggestions of private sector involvement highlights that the official debate has also begun.

It seems strange then that Europe is looking to loan Greece more funds despite a growing consensus that they are unable to pay the money back.

Estimates by GS put the official sector holding of Greek debt at 42% and when we add in the Greek banks (17.9%) it is clear that providing new loans to Greece 1) increases the potential losses to the taxpayer or 2) increases the likely losses to the private sector.

The question on Greece is not so much how much longer the solvency question can be delayed but how much of the eventual pain will be shared between the private and public sector.

The answer to this question will likely depend upon the impact on the financial sector in the core countries and the political necessity from Germany and France not to crystallize losses ahead of national elections in both countries.

Sometime during 2013 seems the most likely option to consider a hard restructuring but for now the EU, ECB and IMF are looking to "kick the can down the road".

Once Greece is given another lifeline the focus will shift to whether Ireland and Portugal will be able to stick to their plans in the face of what will be a very difficult growth environment.

With the 10-year yield for both Ireland and Portugal hitting higher highs and the 10-year spread to bunds also at a record wide recently, there is little sign that confidence from the buy-side is making a comeback.This is also the message from the 5-year CDS spread which continues to hug its widest levels.

The most positive aspect has been that the degree of contagion to Spain and Italy has once again been contained.

This unstable equilibrium is likely to persist at least until we start to shift the debate toward a restructuring not only for Greece but also Ireland and Portugal.

As long as the buy side continues to shun the debt of Ireland and Portugal a restructuring for both will remain a central scenario.

COPYRIGHT REUTERS, 2011