Greece Default Likely Over Three Years, El-Erian Says

Mohamed El-Erian, CEO of PIMCO
Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. (PIMCO). Photographer: Ramin Talaie/Bloomberg

Greece is likely to default over the next three years because budget-cutting won’t be enough to reduce the nation’s debt burden, Pacific Investment Management Co. Chief Executive Officer Mohamed A. El-Erian said.

It’s in Greece’s interest to default “as long as you can contain the contagion to other countries and it is done through orderly restructuring and repricing to retain competitiveness,” El-Erian said at a conference sponsored by the Economist magazine in New York yesterday. Like Latin America’s “lost decade” in the 1980s, “the alternative doesn’t promise growth and employment generation,” he said.

The extra yield, or spread, investors demand to hold Greek debt instead of similar-maturity German bonds jumped to a two-week high today. The European Union and International Monetary Fund approved a 110 billion-euro ($153 billion) aid package on May 2 in exchange for Greece agreeing to cut public-sector wages and pensions and raise taxes on fuel, alcohol and cigarettes.

“Greek bonds have been under pressure since El-Erian’s comments,” said Orlando Green, assistant director of capital-markets strategy at Credit Agricole Corporate & Investment Bank in London. “The near-term picture doesn’t look so bad for Greece, but it’s a long journey ahead.”

Greek bonds slid today, pushing the 10-year yield up 31 basis points to 9.66 percent at 5 p.m. in London, the highest since Oct. 8.

Investors demand 716 basis points, or 7.2 percent, more yield to hold 10-year Greek bonds than they do to hold benchmark German bunds. That’s also the widest spread since Oct. 8.

Election ‘Nervousness’

Prime Minister George Papandreou urged Greeks to vote for his ruling party and its reforms in local elections next month, saying that while he didn’t plan to call early national elections, “a decision by the Greek people” would be needed if the government found itself unable to push through changes.

“There may be some nervousness ahead of the elections” weighing on Greek debt today, Green said.

Europe’s sovereign-debt crisis erupted at the end of 2009 after Greece’s newly elected socialist government said the budget deficit was twice as big as the previous administration disclosed. Irish, Portuguese and Spanish bonds subsequently slumped on concern that Greece’s crisis would be followed by other fiscal problems on Europe’s periphery.

The Bank of Greece today said the nation must push ahead with its deficit-reduction plan. “Fiscal consolidation must now move at a much faster pace, with drastic limitation in public-sector waste,” the central bank said in an e-mailed report.

‘Heroic’ Target

Papandreou has promised austerity measures amounting to 11 percent of gross domestic product, according to IMF data.

“I have never seen an 11 percent adjustment on the fiscal side being delivered” under the current program’s assumptions, said El-Erian, who worked at the IMF for 15 years. “Eleven percent is heroic.”

Credit-default swaps protecting Greek government bonds for five years cost 668.5 basis points, according to CMA in London today. Swap prices surged before the May rescue plan and had eased since then, suggesting Papandreou’s austerity measures had bought the country time to reduce a budget deficit that’s more than four times the European Union’s limit.

The EU estimated Greece’s 2009 deficit at 13.6 percent of gross domestic product, the bloc’s highest after Ireland, and projects a shortfall this year of 7.8 percent of GDP.

“The fiscal adjustment that Greece needs to do is unprecedented,” Giada Giani, senior European economist at Citigroup Inc., said at a conference in Brussels today. “There is a limit to the amount of fiscal tightening a country can bear and support without the tightening becoming self-defeating, so detrimental for economic growth that it doesn’t really deliver an improvement.”

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