* Investors doubtful on deal
* Greek finance minister hails bond swap
* Government faces economic, political, social challenges
By Kirsten Donovan
LONDON, March 9 Greece may have negotiated the biggest sovereign debt restructuring in history but early prices on new bonds to be issued to creditors showed investors had little faith that the deal would mean an end to Athens' economic nightmare.
Under the deal, private creditors swap old Greek bonds for new ones with a much lower face value, lower interest rates and longer maturities, losing about 74 percent on the value of their investments and slicing 100 billion euros off the national debt.
Greece's austerity and reform programme demanded by the IMF and the EU means that its debt burden in 2020 should be proportionately similar to that at the moment of Portugal.
This means yields on Greek and Portuguese bonds should be similar, provided investors believe Athens will meet its debt target. This was not the case on the "grey market", where traders quote prices before a security is issued, with yields at 15-21 percent, far above Portuguese levels around 11-14 percent.
"One would expect the yields on the new Greek bonds to be close to Portugal's levels, where the debt-to-GDP ratio is about 116 percent," one international bond dealer said on Friday.
"But ... the market is pricing a high risk premium, which reflects uncertainty over upcoming elections in Greece and reform implementation risk," the dealer added, saying yields would probably remain around current levels for a few months.
Greece's Finance Minister Evangelos Venizelos hailed the deal, which the nation's international lenders demanded in return for the 130-billion-euro ($172 billion) bailout, as a success for all Greeks who are enduring a long recession.
The European Union said the swap was a "decisive contribution to financial stability in the euro area".
But Greece is a long way from solving its daunting economic, political and social problems. Reforms demanded by the EU and IMF alongside deep budget cuts provoked bloody street riots.
The country also faces elections in April or May when pro-bailout conservatives and socialists face an array of smaller parties to the left and right that reject the rescue, and may struggle to form an effective government.
"RISK NOT OVER"
ING rate strategist Alessandro Giansanti said the prices on Friday's grey market reflected around an 80 percent probability of default although the bonds may go up in value in time.
"Everyone agrees the risk for Greece is still not over," Giansanti said. "But maybe the market will need some time to adjust to the exchange."
Another trader, commenting on the yields, said: "That's still showing that the market doesn't have faith that Greece is able to pay its debts, even if you defer it for 20 or 30 years."
Greece will hand private creditors 20 new bonds as part of the debt exchange to try and deal with its colossal debt.
Creditors tendered 85.8 percent of the 177 billion euros in bonds regulated by Greek law. This will reach 95.7 percent of all privately-held Greek debt once "collective action clauses" are enacted to force the deal on creditors who refused to take part voluntarily.
But Greece's target debt level of 120 percent of annual economic output is still seen as unsustainable and analysts say Athens may need another bailout as early as next year.
A February 2042 bond to be issued on Monday was quoted with a yield of around 15 percent, while a February 2023 bond yielded nearer 20 percent, around 6.5 percentage points more than a comparable maturity Portuguese bond.
Greek bond holders were widely assumed to be in line for a 74 percent loss on the value of their holdings in net present value terms -- the real loss suffered by investors -- taking into account factors such as future interest rates.
That would have equated to a yield of around 12 percent on the new bonds. A 15 percent yield implies a loss of close to 76 percent, while a 20 percent yield equates to an almost 80 percent loss, Credit Agricole rate strategist Peter Chatwell said, adding the initial pricing might be a knee-jerk reaction.
"The amount of holders of Greek bonds for speculative reasons was probably quite elevated and it's not clear if they would be long-term holders of the new bonds so it's perfectly rational if we get a bout of selling followed by some stabilisation," he said.