I n sig h ts Greece: Restoring the Economy

May 2011

Please visit
jpmorgan.com/institutional
for access to all of our Insights
publications.
Greeces sovereign debt crisis is once again taking
centre stage. Several options are under discussion to
provide further support for Greece, including a new
aid package, an updated set of fiscal measures and a
debt restructuring programme. Although the situation
is still evolving, we take a look at what solutions
may be feasible. In addition, we try to establish what
effect a debt restructuring may have on the European
and global economy.

Aid and Action

A year ago, Greece agreed to a EUR 110 billion aid package from the European Union
(EU) and the International Monetary Fund (IMF). The aid was provided subject to the
implementation of a rigorous economic and fiscal plan based on public spending
cuts, a reduction in tax evasion, structural reforms and privatisations. Although most
fiscal targets have been met, the industrial and economic weaknesses of the country
have so far made the process very challenging. In the next few years, Greeces
financing needs are expected to surpass the amount of aid, implying new
extraordinary adjustments will be necessary.

Eurozone finance ministers are evaluating whether to expand the aid package to a
maximum of EUR 170 billion. Meanwhile, a more effective privatisation programme,
announced by the Greek government, could help improve the situation. Expected
inflows are estimated to be EUR 50 billion including real estate disposals, with an
estimated 20% reduction to the debt-to-GDP ratio by 2015. The target is to provide
Author enough funding so that Greece has no need to return to the market for finance in
2012 or 2013, thereby enabling the Greek government to concentrate on the reforms
and structural adjustments that are needed to return to a sustainable debt path.

Maria Paola Toschi
Vice President
Market Strategist, Milan
maria.p.toschi@jpmorgan.com
Debt Restructuring
Sovereign debt restructuring implies swapping outstanding bonds with new
instruments with a prolonged maturity and/or a reduced interest rate level. This
could mean a reduction in the value of the bonds already placed on the market
(known as a haircut). The agreed financing obtained from the EU and the IMF has
already implied an average duration extension, which could still be prolonged.
Greece: Restoring the Economy
Exhibit 1: Ten-year bond interest rates spread of peripheral countries versus German Bunds
1,000
Italy Spain Portugal Ireland
800
Basis points
600
400
200
0
Jan-08 Jul-08 Jan-09
Source: Bloomberg, J.P. Morgan Asset Management. Data as of May 10, 2011.
Meanwhile, the average floating interest rate is already very
low compared to the market level.
A debt restructuring would involve a substantial haircut for
institutional and private investors who hold Greek bonds. The
European financial sector could be penalised by losses on bond
portfolios. According to data from the Bank for International
Settlements (BIS), German and French banks, together with
Hellenic banks, are most exposed. In addition, in the case of
default for some Greek banks that are overly exposed to
government bonds, there could be an additional indirect
contagion effect due to the presence of Hellenic bank bonds in
the portfolios of many European financial institutions.
Losses or write-offs on bank portfolios would potentially lead
to a more fragile financial system, further recapitalisation
needs and have an unfavourable impact on credit growth. A
restructuring may also hurt individual bond holders and could
lead to a reduced propensity to underwrite new government
issues. This would be particularly challenging due to the
recent increase in issuance and current financing needs
related to the huge amount of debt at the European level.
In terms of the extent of any restructuring we must distinguish
between preemptive and post-default cases. In the former
situation, the negative impact on bond values is limited, while
in the latter, the haircut, and therefore the global impact, is
much greater. A feasible way out from the Greek crisis could
be through additional aid, privatisations and a soft
restructuring. A preemptive restructuring would be feasible
because Greek bond prices are already discounting such an
eventuality. We do not believe the market rumors about
Greeces exit from the Monetary Union as this would have
extremely negative implications on the euro project and euro
credibility. The main challenge for Greece will be to find a way
to stimulate production and innovation in order to put the
economy on a path of sustainable development.
2 | Greece: Restoring the Economy
Greece
Jul-09 Jan-10 Jul-10 Jan-11
The Economy at a Glance
The Greek crisis became evident when the Greek government
announced a deficit-to-GDP level of 15.4% for 2009 and a debt-
to-GDP level of 127.1%. In May 2010, the EU and the IMF put
together a EUR 110 billion aid package to support Greece, to be
distributed over three years. The aid was dependent on an
ambitious set of structural fiscal austerity measures in order to
make the Greek public finances sustainable and the Greek
economy more competitive. The idea was to put the country in
a position to return to the financial markets in 2012.
Low competitiveness, the absence of economic growth, and
growing social unrest have meant that the Greek government
has only met part of the economic and fiscal plan. At the end
of 2010 the deficit-to-GDP ratio decreased to 10.5%, but was
still well above the 8% target, and the debt-to-GDP ratio
increased to 142.8%. Despite numerous efforts, fiscal
dynamics do not support an efficient de-leveraging path and
the debt-to-GDP level is expected to increase to 160% in the
coming years, mainly because of a very high primary deficit.
According to recent EU analysis,1 the implementation of the
fiscal plan has been slower than forecast and the 2011 deficit-
to-GDP target of 7.6% is proving very difficult to achieve. The
actual 2011 deficit-to-GDP could be close to 9.5%. Additional
fiscal measures are necessary, which are expected to focus
mainly on improving tax collection.
The Greek economy remains fragile. In 2010, GDP decreased by
4.5% and is expected to decline by a further 3% in 2011 (IMF
estimates). In February 2011, unemployment reached 15% and
industrial production continued to decline. There are reasons to
be positive, with the booming German economy (Greeces main
1
The economic adjustment programme for Greece, Third Review, Feb 2011.
trading partner) contributing to an export rebound in the fourth
quarter of 2010. However, a potential recovery for the Greek
economy may be postponed to 2012/2013, when the EU
estimates GDP growth of 1.1% and 2.1% respectively.
2011 refinancing needs are being covered by international loans.
Under the 2010 EU/IMF aid package, Greece has already
received EUR 53 billion and a further EUR 25 billion is scheduled
for 2011. The EU/IMF disbursements for 2012 and 2013 are EUR
24 billion and EUR 8 billion respectively.2 In 2012, Greece is
therefore expected to refinance three quarters of its maturing
medium- and long-term debt on financial markets, and then
fully roll over debt from summer 2013 onwards. Greece will
have to refinance a huge amount of debt after the assistance
programme, with an estimate of EUR 57 billion in 2013, EUR 81
billion in 2014 and EUR 73 billion in 2015.3
Privatisations are estimated to generate EUR 50 billion,
including real estate disposals, with an estimated positive
impact on debt-to-GDP of 20% by 2015 (government and EU
estimates). Successful privatisations could demonstrate the
capability of Greece to match the European aid reimbursement
and could create stronger credibility for financial assistance
packages, calming protests from sections of the European
public who do not want their countries to support the
peripheral economies (including Ireland and Portugal).
The Contagion Effect
Recent financial history suggests that the default of a bond
issuer can have tough and in some ways unpredictable
contagion effects on a global scale. The Greek crisis has
reminded the market of systemic risk. To let one of the
eurozone members default, or significantly restructure its
debt, may cause considerable problems for global markets.
According to data from the BIS, at the end of the third quarter
of 2010, 21% of Greek debt was held by Greek banks and
pension funds, 19% by French banks, 12% by German banks
and 4% by U.K. banks, while other European banks had limited
exposure (Exhibit 2). Public institutions have already
underwritten 38% of the total debt, limiting contagion risk to
private investors. In this context the main risks of a debt
restructuring and consequent haircut to the value of Greek
bonds are related to:
2,3
The economic adjustment programme for Greece, Third Review, Feb 2011.
the risk of default of some Greek banks and pension funds
a weaker European financial system, mainly in France
and Germany
a weaker fiscal position for other core European countries
involved in a new aid plan
upward pressure on rates for both peripheral and core
European countries
Losses or write-offs on banking portfolios could create a
weaker equity structure and require new rights issues. The
unfavourable impact on the financial system could have a
double effect through a reduction in lending activity to
support growth and development, and the withdrawal of
liquidity from markets absorbed by rights issues needed to
increase the banks TIER 1 and equity ratios in general. The
presence of Greek bank bonds in European banks portfolios
could lead to further write-downs, while losses by individual
bond holders could also reduce interest in underwriting
government bond instruments in a period when public debt
financing needs are rising in the developed world.
Germany is experiencing a very strong economic rebound,
while remaining heavily involved in the support of peripheral
countries. The German government has had to manage public
opposition from those not wanting to provide support to
peripheral countries and is advocating the introduction of
clauses to involve private bond holders in bailout
programmes. Such clauses could make peripheral
governments more committed to austerity measures, but
could also change the risk profile of eurozone sovereign
bonds, which would potentially no longer be seen as risk free.
Exhibit 2: Greek Government bond holders, in EUR (billions)
140
120
100
EUR (billions)
80
60
40
20
0
Greek Greek EU/ French German U.K. Portu- Italian Other
banks PF* IMF* banks banks banks guese banks
banks
Source: BIS. Data as of September 30, 2010.
* Greek PF means Pension Funds. EU/IMF also includes ECB and World Bank.
J.P. Morgan Asset Management | 3
Greece: Restoring the Economy

Uruguay: a preemptive restructuring Argentina: a post-default

In 2003, Uruguay avoided a default, following a long period of restructuring
recession and increasing public deficits, through a sovereign Events in Argentina in 2005 were more acute, as a sovereign
debt restructuring. The government offered bond holders a debt restructuring came after the announcement of a default.
swap of old bonds with new instruments that had an average Different proposals were made to bond holders resulting in a
longer duration. According to IMF data, the haircut in this case lot of international lawsuits, some of which are still pending.
was limited (roughly 8%). At the same time, Uruguay imple- The average haircut to bond values was very high and corre-
mented an austerity programme to reduce its debt-to-GDP ratio sponded to roughly 75%.
from approximately 100% to 65% in three years, and was able
to return after a six-month period to refinance its own debt on
the international financial markets.
The Argentine crisis was acute due to the high level of foreign
and domestic individual investors. The substantial haircut
together with the difficult economic recession heavily
Learning From the Past
penalised the average per capita wealth of Argentinians and
On May 9, 2011, Standard & Poors decided to again undermined consumption for many years.
downgrade Greeces long-term sovereign debt rating to BB-
(from B) and the short-term rating to C (from B), keeping both
ratings on negative credit watch. The downgrade reflects the
increasing probability of a sovereign debt restructuring. The Finding a Suitable Road to Recovery
Credit Default Swap market is pricing a 65% probability of The main challenge for Greece now is to stimulate an economy
default within the next five years. that is still in recession, where there is no growth, production is
in decline and unemployment is increasing. There is also limited
Many European Central Bank (ECB) members, EU ministers
visibility on tax collection and a large shadow economy. These
and observers are strongly against a debt restructuring due to
factors are incongruous to a sustainable recovery, which is
the potential haircut effect on bond values. A restructuring
imperative to ensuring Greece can service its public debt and
could involve a swap of old bonds with new issues, with longer
deficit. Despite the governments strong commitment to a
maturities and/or lower interest rates, so that debt financing
recovery after receiving foreign aid, public deficits are higher
and roll over needs become more sustainable.
than the level intended in the fiscal plan, with the debt-to-GDP
In a 2006 research review, the IMF analyzed the impact of ratio expected to increase in the coming years.
past sovereign debt restructurings (Exhibit 3). In all cases the
countries involved experienced a period of recession, with
Exhibit 3: Some sovereign debt restructuring events
increased public debt levels and higher financing costs.
Debt affected
However, the consequences and economic impact were very
Debt-to-GDP, NAV % of % of
different in cases of preemptive restructuring to cases of post- Countries Year 2004 (%) reduction* GDP debt
default restructuring. Two examples of these differences are Preemptive
Uruguay, where a preemptive sovereign debt restructuring Ukraine 1999 27.1 5 12.8 20.9
occurred in 2003, and Argentina, which experienced a post- Pakistan 1999 67.9 8 1.0 1.0
default restructuring with very dramatic effects in 2005. Moldavia 2002 48.3 6 2.4 3.0

According to IMF analysis, the majority of cases of preemptive Uruguay 2003 92.5 8 48.3 49.3
Dominican
sovereign debt restructuring were based on maturity Republic 2005 54.1 1 7.0 14.3
extension and had a limited haircut effect. This is true
Post default
especially when the event is already expected by the markets,
Ecuador 2000 47.2 25 49.4 45.0
and when bond market prices are already discounting losses, Russia 2000 21.7 44 23.7 39.3
as with Greek bonds. Argentina 2005 129.4 75 59.7 53.1
The systemic impact can also be very different depending on Source: Cross-Country Experience with Restructuring of Sovereign Debt and
Restoring Debt Sustainability, IMF, August 29, 2006.
the ratio of sovereign debt underwritten by foreign or
* Note: mainly IMF estimates.
domestic investors, and/or by institutional or private investors.

4 | Greece: Restoring the Economy

The sovereign debt crisis in Greece is still evolving. At present,
a debt restructuring appears to lack support from many ECB
members, some of whom voiced their concern in recent
weeks. The risk of contagion still exists. Greek and core
European banking systems face risks from their high exposure
to Greek government bonds. However, monetary aid from the
IMF/EU is helping to limit potential contagion as credit from
the aid programme is gradually replacing debt in the private
system, making the environment less risky.
It is too early to predict an outcome of the crisis as there are
both economic and political issues to consider. Nevertheless,
we can speculate over some possible scenarios:
1. We do not consider an exit from the eurozone or Monetary
Union as a viable option as the unfavourable implications
on the European project, euro credibility and the
European aid structure could be high. Ireland and Portugal
may also face further difficulties, therefore, the aid system
must remain available and made to work efficiently.
2. Returning to the drachma after 12 years of using the euro
could limit Greeces opportunity to recover from the crisis
and does not exclude sovereign debt contagion risk to
other European countries.
3. A soft preemptive sovereign debt restructuring could lead
to a limited reduction in the value of Greek bonds,
especially because the market is already discounting
a restructuring.
4. On the other hand, not intervening could create a more
difficult environment than the present one, with eventual
higher costs and a more acute contagion effect in the next
few years.
5. A final decision could be postponed. The real refinancing
risk is related to the expiration of debt mainly in 2013.
This means that a decision is not urgent and there is more
time to understand and evaluate the economic situation.
However, uncertainty may continue to cause volatility in
the financial markets.
We believe aid from the European Stability Mechanism, which
will be operative from 2013, foreign control on the privati-
sation process and a soft preemptive restructuring, with a
limited reduction in the value of bonds, could help stabilise
the Greek economy. The level of Greek bonds on the markets
is already discounting a partial intervention. This could be a
pre-condition to limit unwanted shocks on the markets.
Overall, we think that bond markets will remain volatile even
in core Europe, due to uncertainty in the periphery. Sovereign
debt issues, particularly in Portugal and Ireland, will continue
to contribute to an environment of significant, long-term
constraints on future growth for the core European countries
involved in the bailouts. Europe will likely remain focused on
bailout mechanisms, absorbing an increasing amount of
resources. However, core Europe cannot continue to finance
peripheral economies if there is not a medium-term plan to
return them to self-sustainability.
Equities will also continue to suffer from the sovereign debt
uncertainty. Despite Greek bonds trading at a discount, they may
still be considered at par value in portfolios and not at market
value, meaning there is room for write-offs and devaluations.
About the author
Maria Paola Toschi, vice president, is a market strategist at
J.P. Morgan Asset Management in the Milan Office, in charge of
communications to domestic retail and institutional clients.
She worked from 1986 to 2003 as a sell-side equity analyst
in different Italian banking institutions and has spent the last
eight years in Banca IMI, Intesa Sanpaolo Banking Group,
mainly covering small-mid Industrial companies and following
several IPOs. In 2003 she became responsible for the retail
investment communications team dedicated to the Sanpaolo
Retail and Private Banking network. She graduated in Economics
at the Milan L. Bocconi University and has been a Member of
the Italian Financial Analysts Association since 1989. She joined
J.P. Morgan Asset Management Milan in November 2008.
J.P. Morgan Asset Management | 5
Greece: Restoring the Economy

Important disclaimer
This material is intended to report solely on the investment strategies and opportunities identified by J.P. Morgan Asset Management. Additional information is available
upon request. Information herein is believed to be reliable but J.P. Morgan Asset Management does not warrant its completeness or accuracy. Opinions and estimates
constitute our judgment and are subject to change without notice. Past performance is not indicative of future results. The material is not intended as an offer or solicita-
tion for the purchase or sale of any financial instrument. J.P. Morgan Asset Management and/or its affiliates and employees may hold a position or act as market maker in
the financial instruments of any issuer discussed herein or act as underwriter, placement agent, advisor or lender to such issuer. The investments and strategies discussed
herein may not be suitable for all investors. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recom-
mendations. Changes in rates of exchange may have an adverse effect on the value, price or income of investments.
All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. Results shown are not meant to be
representative of actual investment results. Any securities mentioned throughout the presentation are shown for illustrative purposes only and should not be interpreted
as recommendations to buy or sell. A full list of firm recommendations for the past year is available upon request.
International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies
outside the U.S. can raise or lower returns. Also, some overseas markets may not be as politically and economically stable as the United States and other nations. The
Funds investments in emerging markets could lead to more volatility in the value of the Fund. As mentioned above, the normal risks of investing in foreign countries are
heightened when investing in emerging markets. In addition, the small size of securities markets and the low trading volume may lead to a lack of liquidity, which leads to
increased volatility. Also, emerging markets may not provide adequate legal protection for private or foreign investment or private property.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the
following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited which is regulated by the Financial Services Authority; in other EU jurisdictions by
JPMorgan Asset Management (Europe) S. r.l., Issued in Switzerland by J.P. Morgan (Suisse) SA, which is regulated by the Swiss Financial Market Supervisory Authority
FINMA; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited, all of which are
regulated by the Securities and Futures Commission; in Singapore by JPMorgan Asset Management (Singapore) Limited which is regulated by the Monetary Authority of
Singapore; in Japan by JPMorgan Securities Japan Limited which is regulated by the Financial Services Agency, in Australia by JPMorgan Asset Management (Australia)
Limited which is regulated by the Australian Securities and Investments Commission and in the United States by J.P. Morgan Investment Management Inc. which is regu-
lated by the Securities and Exchange Commission. Accordingly this document should not be circulated or presented to persons other than to institutional, professional
or wholesale investors as defined in the relevant local regulations. The value of investments and the income from them may fall as well as rise and investors may not get
back the full amount invested.
270 Park Avenue, New York, NY 10017
2011 JPMorgan Chase & Co. | INSIGHTS_Greece: Restoring the Economy

jpmorgan.com/institutional