Analysis: Euro zone weaklings face big debt hurdles in 2011

By William James

LONDON (BestGrowthStock) – Investors’ concern about the creditworthiness of highly indebted euro zone countries will make it hard for some states to finance hefty debt repayments in the first half of 2011, even as new issuance in the bloc falls.

Euro zone countries are expected to borrow less on the bond markets in 2011 than they did this year but the interest rates investors are demanding to buy government debt pose a burden that may become unsustainable for the likes of Spain and Portugal.

As a result, banks are already questioning whether Portugal will be able to tap the private sector for the amounts that must be raised to repay maturing debt, which are higher next year than in 2010.

“The question really out there is ‘who will be willing to buy peripheral paper like Portugal?’,” said Michael Leister strategist at WestLB in Dusseldorf.

“With historic volatility and thin liquidity, the more traditional investor base is taking a really defensive stance on some peripheral issuers.”

Portugal must repay debt of more than 12 billion euros in the first half of 2011, with its first redemption falling in April.

TOTAL ISSUANCE FALLS

Up to 863 billion euros of euro zone debt will be sold in 2011, analysts estimate, down from more than 900 billion euros in 2010, as sovereigns seek to slash the bloated budget deficits that threatened to bring the currency bloc to its knees earlier this year.

Debt agencies will be hoping stiff budget cuts ensure easier and cheaper access to funding after a troubled 2010, when fears over fiscal stability in Greece and Ireland caused debt yields to soar to record levels, leading both states to seek bailouts.

However, political wrangling over how to resolve the crisis permanently looks likely to keep uncertainty, and therefore borrowing costs, high into next year, threatening access to capital markets at a sustainable rate.

“In the absence of Greece and Ireland I’m sure Portugal and Spain will be the market’s main barometer when it comes to the market’s appetite toward the periphery,” said Ioannis Sokos, rate strategist at BNP Paribas.

Portugal is seen by many as next in line to seek bailout funds, with 10-year bond yields at 6.574 percent — well above the rates charged by the European Union/IMF fund.

“I don’t think (Portugal) will make it through 2011 without assistance. If we look at the case of Greece and Ireland, we have seen countries issuing at 6.5 percent, but this is not sustainable,” Sokos added.

If Portugal is to avoid asking for aid, analysts estimate it must raise around 19 billion euros, with the majority of funding undertaken in the first half of the year to pay for sizeable redemptions in April and June.

Analysts put Spain’s borrowing requirement at around 90 billion euros, around 5 billion euros below the amount raised in 2010.

After 10-year yields topped 5 percent at Spain’s most recent debt auction, investors will be keeping a close eye on the cost of funding three Spanish bond redemptions, each of around 15 billion euros, in April, July and October.

“I don’t think Spain can fund a full year at over five percent — that would raise some questions — but I am optimistic for now,” said Unicredit strategist Luca Cazzulani.

LESS GERMAN DEBT

Germany, the euro zone’s largest economy and driving force behind the regions’ recovery, has said it will issue less debt, at around 185 billion euros.

Recent sales of German debt have drawn weak demand, and auctions will be closely watched for further signs of waning investor appetite after the country’s last three bond sales of 2010 drew bids worth less than the total amount on offer.

Investors have expressed concern over the impact that more sovereign bailouts would have on German finances, resulting in sharp yield moves in the usually-stable euro zone benchmarks.

“The volatility can hardly increase further for Bunds, and this was one key factor keeping the investor base on the sidelines. As the bigger picture of the debt crisis unfolds we still see some rebalancing in favor of Bunds,” Leister said.

Across the currency bloc, debt agencies will look to extend the duration of their outstanding debt in an effort to distance themselves from the high levels of short-term bonds and bills issued in the wake of the 2008 financial crisis.

Ireland and Greece are expected to draw on funds from the European Union/International Monetary Fund bailout and although both have left the door open to bond issuance later in the year, analysts say activity is likely to be limited to rolling over their stocks of T-bills.

(Graphic by Vincent Flasseur)

Analysis: Euro zone weaklings face big debt hurdles in 2011