LONDON Financial markets have increased bets Greece will have to restructure its debt or face a default in the medium to longer term to tackle its fiscal problems even if it clinches a planned three-year aid package.
The cost of insuring Greek debt against default has surged to ever higher records and the cost of raising capital to pay off old debts and run the country is at its highest since at least early 1998 as investors have cast doubt on whether the deal is enough to resolve Athens's structural problems.
The package, under which Greece would receive some 45 billion euros (39 billion pounds) from the European Union and International Monetary Fund, is seen sufficient only to stave off default for 12 to 36 months.
After that time, questions remain over how Greece will tackle its fiscal problems because it is doubtful that any aid package agreed this year would be extended beyond that.
Analysts and traders have outlined a range of options for Greece, or any other euro zone country that might face a similar position, if it is unable to make payments on its bonds.
NEGOTIATED DEBT RESTRUCTURING
PROBABILITY: most likely in the medium to long term
Greece would negotiate a restructuring of its debt before missing a payment. This would require investors to take a significant discount on their debt holdings and could include extending maturities or possibly investors switching to longer maturities.
Bondholders could, however, see haircuts of anything from 20 to 40 percent of the net asset value of their debt positions, according to some analysts' calculations.
According to Brown Brothers Harriman's calculations, the current two-year Greek/German bond yield spread is consistent with about a 25 percent chance of a 50 percent haircut or about a 33 percent chance of a 40 percent haircut.
The two-year Greek/German bond yield spread has ballooned to more than 1,400 basis points as investors pummelled Greek debt.
MARKET IMPACT: Spreads on other highly-indebted countries in the euro zone would widen sharply while German benchmarks would benefit from flight to quality and the euro could fall to around $1.15, levels last seen in 2005.
UNILATERAL DEBT RESTRUCTURING
PROBABILITY: highly unlikely
Greece could impose a debt restructuring on its creditors, for example extending maturities or forcing investors to take haircuts without prior agreement.
Historically, non-negotiated restructuring are more likely to result in a haircut for creditors than are agreed restructurings.
An even more unlikely outcome under this scenario is that markets punish Greece so severely that, despite enormous legal and logistical obstacles, Athens would elect to leave the euro zone and European Union.
However, market consensus is that leaving the currency union would make it even more costly for any fiscally weaker country to borrow because of the addition of an exchange risk premium to the sovereign risk premium.
MARKET IMPACT: The euro would be hit even harder as markets would as a knee-jerk reaction price in a greater risk of euro zone disintegration. Spreads of higher-yielding euro zone countries would blow out even further versus German benchmarks.
PROBABILITY: highly unlikely
About 70 percent of Greek debt is estimated to be held by foreigners, most of them within the euro zone, notably German and French financial institutions. European Union officials will try to avoid an outright default.
An outright default by Greece or any country facing a similar situation would mean exclusion from capital markets, as happened with Argentina when it defaulted in 2001. The South American country has not issued any euro or dollar-denominated debt since then as it has yet to come to an agreement with international creditors.
MARKET IMPACT: The euro would most likely fall below parity against the dollar, intra euro zone bond yield spreads would blow out, with the bond market for other countries facing fiscal challenges drying up, leaving only triple-A rated countries able to issue debt.
Other possibilities include the European Central Bank providing loans to help Greece meet its obligations, buying Greek bonds or relaxing its collateral rules yet further to accept any bonds as collateral irrespective of their ratings.
However, such scenarios are seen as outliers as they would require political or policy decisions that analysts say would be very difficult to achieve.
Another complicating factor is that many investors have bet on a default through credit default swaps and thus have a vested interest in forcing such an outcome.
(Reporting by Emelia Sithole-Matarise)