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

Concern that Papademos won't have domestic backing to achieve spending cuts needed to win more funds or that they will further hamper growth helped drive Greek two-year yields to an all-time high of 185 percent on Jan. 10. The yield on Greek benchmark debt maturing in October 2022 fell 46 basis points to 33.55 percent today, after hitting a record of 36.14 percent on Dec. 21.

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

Frank Vogl, an IIF spokesman, blamed the breakdown in talks on disagreement over the coupon, or interest rate, to be paid on new bonds and on discord among different authorities involved in the talks. The IIF is representing bondholders in the talks with officials from the International Monetary Fund, the European Union and the Greek government.

“There have been differences of views among the official parties to the negotiations, despite the best efforts of the Greek government's leadership,” Vogl said yesterday. It's important that the talks conclude “as soon as possible,” he said.

Debt Burden

The proposed swap aims to slice 100 billion euros from the 205 billion euros of privately owned Greek debt, with the help of 30 billion euros in cash for incentives to reach a debt-to-gross domestic product ratio of 120 percent by the end of 2020. That will relieve Greece of some 4 billion euros in annual debt servicing costs. The ratio was 162 percent in 2011, according to IMF estimates.

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

Greece's public debt management agency head Petros Christodoulou and George Zanias, the chairman of the council of economic advisers, traveled to Washington yesterday to meet with members of the IMF in Washington to discuss the swap, a finance ministry official said, confirming an Imerisia newspaper report.

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

European governments have been pushing for the Greek debt to carry a coupon of 4 percent, said a person with direct knowledge of the negotiations on Jan. 13. Private bondholders said they would accept those terms for a period of time if they were able to get a bigger 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 range offered by investors to ensure Greece meets its deficit targets as the economic outlook worsens.

After two years of wage cuts and tax increases, the IMF estimates the country's 2011 deficit at about 9 percent of GDP, down from 10.6 percent in 2010. The economy was expected to shrink about 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 its forecasts for Greece three times in six months last year and delay the payment of loans under the May 2010 package, with an 8 billion-euro outlay originally due in September being paid last month. Failure to complete the voluntary swap threatens to further undermine confidence in the EU's crisis leadership.

Ability to Pay

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

Hedge funds holding Greek bonds may resist a deal, seeking to reap greater profit by getting paid in full, either by the Greek government or by triggering payouts from default-swap insurance contracts.

Finance Minister Evangelos Venizelos said Jan. 14 his country aims to present the outline of the plan at a meeting of euro-area finance ministers on Jan. 23, with a final agreement taking until early 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 last month 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 week at a yield of 4.9 percent, compared with 4.95 percent at the previous such sale on Dec. 13.

The downgrade of European ratings by S&P last week suggests countries can fail to meet their debt obligations and Greece will prove to be the latest example, Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., said in a Twitter posting yesterday.

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

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

Portuguese Yields

Portugal and Cyprus are the other two euro-area countries that lost their investment grade status last week at S&P. Portugal is already in an EU-sponsored bailout plan, like Greece, to shield the country from high borrowing costs. Cyprus, whose three biggest banks together hold more than 5 billion euros in Greek government debt, isn't.

Portugal's 10-year borrowing cost surged to a record 14.3 percent yesterday, climbing almost 1.9 percentage points in the wake of the rating downgrade. The yield is little changed at about 13.23 percent today.

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

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