What are Greek bonds worth?

The benchmark GGB 6¼% of 2020 is selling at 51.735. The average closing price over the 12/31/10-6/15/11 period has been 64.2. At current prices, the market is saying that Greece can’t service a debt that reaches 160% of GDP and that the country needs to cut such debt almost in half. I agree. But the market also says that the inevitable restructuring will wipe 48% of the public debts outstanding. I disagree.
 

With over €300 billion of public assets potentially available for sale (according to Mr. Juergen Stark of the ECB board), it seems to me extremely difficult that Greece could convince private creditors and fellow EU members that half of its €320 billion in public debt be forgiven.

Nor should it. If it did, it and the rest of the EU would lose market confidence for a long time, and the weaker EU member countries would suffer serious financial dislocation. As it is evident from the current riots and the reticence of local politicians, imposing drastic austerity measures would be very difficult, and possibly unproductive.

The only viable alternative is an expanded asset sale and privatization program, one that would generate €100 billion in cash proceeds. This, coupled with a rescheduling of the remaining debt via longer maturities and below market rates (in all equivalent to a 15%-20% “haircut”), would effectively put Greece back on track.

The problem is that there would be a timing mismatch between Greek debt maturities and asset sales and privatizations. Nevertheless, this problem can be solved provided that the appropriate laws are passed, a credible time-table is agreed upon and (some) assets for sale are put into some kind of trust for the benefit of the EU members and supranational entities that would buy debt maturities and be repaid with the proceeds of privation and asset sales.
Initial popular sentiment may be against such a large asset sale. But if properly explained, it would be more palatable than more drastic austerity measures. Furthermore, popular approval could be gained by introducing a form of capitalismo popular (see earlier articles below) whereby Greek households would obtain attractive financing to participate in these privatizations.

No solution will be easy, but some are better than others. Under most reasonable scenarios, Greek public debt should trade well above current prices.

We hold no position, long or short, in Greek debt.

Peru: Looking to the future

The day after Ollanta Humala was voted the next president of Peru, the Lima stock market dropped by a record 12.5%.  Was such a move justified?  What should investors make of the new president?

In our view, given how much Peruvian stocks had risen over the previous decade and how real the political uncertainty now is, the selloff was not irrational.  As to whether investors standing on the sidelines should capitalize on the correction and buy, we would advise to wait at least six months.

President Humala, like his Venezuelan counterpart, led a military revolt against a democratically elected government; that was in 2000.  Like him, he has openly stated his wish to transform the society of his country, essentially by increasing the participation of the state in the economy and transferring more of the country’s revenues to the poor.  In the early days of the 2011 presidential campaign, Mr. Humala announced that he would seek to amend the Peruvian constitution, revise upward the taxes and royalties levied on the mining sector (the largest contributor to the economy) and nationalize private pensions.  As the presidential race tightened, Mr. Humala adopted a more moderate line.

The Peruvian political class has made a very visible show of solidarity with the new president.  This, in our view, has been both to calm markets and to insure that the new president remains within the main stream.   Mrs. K. Fujimori, whom Mr. Humala defeated in the second round, stressed that she would go to his campaign headquarters to congratulate him.  Outgoing President A. Garcia promised support and encouraged the population to rally behind the new president.  He also suggested that President D. Rousseff from Brazil come to the inauguration and talk with Mr. Humala.

Mr.Humala may turn out to be a progressive but moderate president.  Time will tell.  Nevertheless, a study of history, in both Europe and Latin America, shows that aspiring leaders driven by a strong ideology tend to fulfill the promises they made in their younger days.

President Evo Morales of Bolivia had promised to regain control of the oil and gas and mining industries, and he did so shortly after he was elected via a nationalization which, in the case of oil and gas, amounted to an expropriation (no compensation was paid for the assets seized, foreign oil companies that agreed to stay in Bolivia would be paid for their future services, those that didn’t stay would get nothing).  He also promised to substantially improve transfer payments to the poor and he did so.

President Chavez of Venezuela promised a similar vision, one of socialism entailing deep involvement of the state in the economy.  However, perhaps advised by Fidel Castro, he adopted a more gradual strategy of change; in his first cabinet, he appointed both revolutionary companions and mainstream figures (retaining Mrs. M. Izaquirre as economy minister); deeper political changes were secured via referenda and a new constitution.  When President Chavez first moved to increase his control over the economy, he targeted local groups, insuring that foreign companies and governments would stay put.  Then he went after foreign oil, cement and other multinationals.  Some of the biggest conflicts with oil multinationals took place eight years after President Chavez was first elected.

The moral is that political leaders who are driven by deeply felt ideologies tend to remain true to them through most of their lives.  Of course, history doesn’t repeat itself.  President Morales took President Lula by surprise when he nationalized the assets of Petrobras.  Such a move is unlikely to be repeated today.  President Chavez was very careful in how he reshaped the economy of Venezuela; but such a stealth strategy would be more difficult to implement today.

One argument that is often advanced by optimists is that leaders with a social agenda, and committed to improving the condition of the poor, must insure that their economy prosper so that they create the revenues they need.  But this reflects the thinking of a pragmatist, not of someone driven by ideology and committed, first and foremost, to social change.  Lenin reneged on Russia’s foreign debt and nationalized all land estates; the Venezuelan economy under President Chavez has performed very poorly.  Clearly, social transformation was the prime goal of these two political leaders, not social-democracy.

In a sense, the game is on already.  Mainstream figures hope that President Rousseff of Brazil will steer President Humala towards a moderate path where social transfers are financed via economic growth rather than nationalizations and the take-over of private pensions.  Initially, President Chavez was uncharacteristically discreet in his comments, but then truer to form in declaring that Mr. Umala's victory had been over bourgeois capitalism.  Even if reality were to push him toward the center, President Humala would have to contend with the promises he made and the expectations of his followers and allies.  One only has to look at the pressure applied by some in the Democratic Party on President Obama, no leftist he, to gauge the potential problem. 

Finally, another area deserving of attention will be the new president’s regional foreign policy.  A long standing source of conflict is the Guerra del Pacifico which pinned Chile against Peru and Bolivia in the 1880s.  Chile won.  While Chile and Peru subsequently reached agreement regarding contested territorial borders, Peru is disputing some of its maritime borders before the International Court of Justice in the Hague and Bolivia continues to demand from Chile direct access to the Pacific Ocean.  These issues resonate in all three countries, and President Humala has been quite vocal about the border issue and also the Guerra del Pacifico itself.  How he will handle this matter now that he is president will matter a great deal.

It is important to note that President Humala was democratically elected in a vote which had a very high  turnout of 70%.  Yet, there are enough uncertainties regarding future policies that a prudent investor should wait until he can make a more educated judgment regarding political risks.  Furthermore, current Peruvian stock valuations are not so low that the urge to invest can't be resisted.