Greece is running out of time to avoid becoming the first euronation to default after talks with lenders stalled ahead of a March20 bond payment that will cost 14.5 billion euros ($18 billion) thecountry doesn't have.

Prime Minister Lucas Papademos is due to meet tomorrow with agroup representing private Greek bondholders after a five-day breakto discuss forgiving at least half of the nation's debt in the euroarea's first sovereign restructuring. Greece's official creditorsbegin talks Jan. 20 on spending curbs and budget cuts that willdetermine whether to disburse additional aid. Edward Parker, amanaging director at Fitch Ratings in London, said today Greece isunlikely to make next month's bond payment.

“The next few weeks will be the most difficult in the Greekprogram,” said Athanasios Vamvakidis, a foreign-exchange strategistat Bank of America Corp. in London. “All this needs to be completedby mid-March to avoid a disorderly default. Not an impossible task,but clearly very challenging with very much at stake.”

Until the debt swap and loan accord are in place, the countryfaces “acute economic risks,” Papademos said on Jan. 13. Greecesold 1.625 billion euros of 13-week Treasury bills today at a yieldof 4.64 percent, with short-maturity debt sales the only source ofmarket financing available for the nation. Bonds repayable in 2022are worth about a third of their face value.

Greece and its creditors are “running out of time,” MoritzKraemer, the head of sovereign ratings at Standard & Poor'sCorp., said in an interview yesterday with Andrea Catherwood onBloomberg Television's “Last Word.” Kraemer said he can't say“whether there will be a solution at the end of the current rockynegotiations. There's a lot of brinkmanship going on rightnow.”

Concern that Papademos won't have domestic backing to achievespending cuts needed to win more funds or that they will furtherhamper growth helped drive Greek two-year yields to an all-timehigh of 185 percent on Jan. 10. The yield on Greek benchmark debtmaturing in October 2022 fell 46 basis points to 33.55 percenttoday, after hitting a record of 36.14 percent on Dec. 21.

Greece plans to pay lenders 50 cents for each euro thegovernment borrowed under the terms of a bailout plan agreed onOct. 26. Its 4 percent notes due in August 2013 trade at about 27cents. Fitch says an agreement would amount to a “default event”once implemented, while the International Swaps and DerivativesAssociation says it won't trigger credit-default swaps bought byinvestors as insurance against the country failing to meet itsobligations.

Frank Vogl, an IIF spokesman, blamed the breakdown in talks ondisagreement over the coupon, or interest rate, to be paid on newbonds and on discord among different authorities involved in thetalks. The IIF is representing bondholders in the talks withofficials from the International Monetary Fund, the European Unionand the Greek government.

“There have been differences of views among the official partiesto the negotiations, despite the best efforts of the Greekgovernment's leadership,” Vogl said yesterday. It's important thatthe talks conclude “as soon as possible,” he said.

Debt Burden

The proposed swap aims to slice 100 billion euros from the 205billion euros of privately owned Greek debt, with the help of 30billion euros in cash for incentives to reach a debt-to-grossdomestic product ratio of 120 percent by the end of 2020. That willrelieve Greece of some 4 billion euros in annual debt servicingcosts. The ratio was 162 percent in 2011, according to IMFestimates.

The targeted ratio is a “realistic outcome” for the talks,European Central Bank President Mario Draghi said yesterday at theEuropean Parliament in Strasbourg. Slower growth and a lack ofprogress on reforms since the Oct. 26 summit make it essential thatthe talks address how Greece will meet its debt obligations, Draghisaid.

Greece's public debt management agency head Petros Christodoulouand George Zanias, the chairman of the council of economicadvisers, traveled to Washington yesterday to meet with members ofthe IMF in Washington to discuss the swap, a finance ministryofficial said, confirming an Imerisia newspaper report.

“I still hope that they come to a solution because it isabsolutely crucial,” Deutsche Bank AG Chief Executive Officer JosefAckermann, who is also the chairman of the IIF, said yesterday. “Ithink we are in a situation where everybody is trying to get themost out of it, but in the end we'll come to an agreement.”

European governments have been pushing for the Greek debt tocarry a coupon of 4 percent, said a person with direct knowledge ofthe negotiations on Jan. 13. Private bondholders said they wouldaccept those terms for a period of time if they were able to get abigger payout later as Greece's economy recovered, said the person,who declined to be identified.

The IMF had previously sought a lower coupon than the rangeoffered by investors to ensure Greece meets its deficit targets asthe economic outlook worsens.

After two years of wage cuts and tax increases, the IMFestimates the country's 2011 deficit at about 9 percent of GDP,down from 10.6 percent in 2010. The economy was expected to shrinkabout 6 percent last year, according to the latest IMF estimates,compared with an estimate of 3.8 percent made in June.

An inability to implement reforms led the IMF to cut itsforecasts for Greece three times in six months last year and delaythe payment of loans under the May 2010 package, with an 8billion-euro outlay originally due in September being paid lastmonth. Failure to complete the voluntary swap threatens to furtherundermine confidence in the EU's crisis leadership.

Ability to Pay

“The big problem remains that even if a deal is reached, thedebt burden is still unsustainable,” said Martin Blum, co-head ofasset management at Ithuba Capital in Vienna. “This isn't only abig problem for Greece, it also makes it more difficult forcreditors to reach a deal given they'll still have Greek creditrisk after the deal.”

Hedge funds holding Greek bonds may resist a deal, seeking toreap greater profit by getting paid in full, either by the Greekgovernment or by triggering payouts from default-swap insurancecontracts.

Finance Minister Evangelos Venizelos said Jan. 14 his countryaims to present the outline of the plan at a meeting of euro-areafinance ministers on Jan. 23, with a final agreement taking untilearly March. “It is one thing to have an agreement with creditors,”he said. “It is another to execute the agreement.”

The country is surviving on the 8 billion-euro loan paid lastmonth by the IMF and the EU, and proceeds from treasury bill sales.Greece raised 2 billion euros in a sale of 26-week bills last weekat a yield of 4.9 percent, compared with 4.95 percent at theprevious such sale on Dec. 13.

The downgrade of European ratings by S&P last week suggestscountries can fail to meet their debt obligations and Greece willprove to be the latest example, Bill Gross, who runs the world'sbiggest bond fund at Pacific Investment Management Co., said in aTwitter posting yesterday.

France and Austria lost their top rankings in a series ofdowngrades Jan. 13 that left Germany with the euro area's onlystable AAA grade. S&P cut Greece's grade to CC in July, meaningthe nation's debt is “highly vulnerable” to nonpayment, based onthe company's rating definitions.

“Even if there is a so-called voluntary exchange we would stillconsider this a distressed debt exchange and a default under ourcriteria,” Kraemer of S&P said on a Jan. 14 conference call.“Important to keep in mind is not only the direct impact for thedebt of Greece, but if you had a disorderly default, this may haveworse implications for other sovereign debtors which are undermarket pressure.”

Portuguese Yields

Portugal and Cyprus are the other two euro-area countries thatlost their investment grade status last week at S&P. Portugalis already in an EU-sponsored bailout plan, like Greece, to shieldthe country from high borrowing costs. Cyprus, whose three biggestbanks together hold more than 5 billion euros in Greek governmentdebt, isn't.

Portugal's 10-year borrowing cost surged to a record 14.3percent yesterday, climbing almost 1.9 percentage points in thewake of the rating downgrade. The yield is little changed at about13.23 percent today.

“Unless Greece implements the urgently needed reforms, nohaircut can achieve debt sustainability,” said Vamvakidis. “I thinkthere is more than 50 percent chance they will succeed. My concernis if they don't, there is no clear Plan B. No PSI agreement andvery low participation could increase market uncertainty about whatcould follow.”

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