Investors' fear of Greece harms Czech bonds

The price of insuring Czech government bonds has seen a steep rise in recent weeks, as investor demand for protection against government default grows in the wake of the Greek crisis. The Czech government's plodding progress toward passing structural reforms may be exacerbating the price swell further by making the country a target for speculative investment in credit default swaps (CDS), analysts say.

CDS are a form of insurance that protect the lender in the event of a loan default. In the past month, the price of a CDS for five-year Czech government bonds has risen 20 percent, according to figures from Next Finance, a jump that is especially surprising when compared with CDS cost figures for the same period for government bonds from distressed countries like Italy, Portugal and Greece, which have not increased nearly as much.

Though the fundamentals of the Czech economy are strong, at a time when Greece is in jeopardy of defaulting on its bonds, investors are second-guessing the safety of all European government bonds and increasingly taking out CDS as insurance against a default, said Martin Prokop, an analyst with Next Finance.

At the same time, speculative investors are placing their bets on whether the Czech government will pass reforms to lower the deficit - thereby increasing or decreasing the reliability of government bonds - by buying or selling CDS.

"The statistics on this are not well kept, so we can't say how much insurance demand was because of speculation and how much was actual insurance, but I think speculation could be behind it," Prokop said.

If speculative dealing is behind the price increase, Prokop said the successful passage of pension reform and healthcare reform would signal to investors that the government is serious about lowering the deficit, which would put the brakes on speculative trading in CDS.

"The only other thing they can do is intervene on the market side to show that GDP growth is strong," Prokop said.

Whatever the cause for the higher cost of CDS insurance for government bonds, investors are not likely to stop purchasing the bonds anytime soon. Prokop said the most recent bond issue from the government drew twice as many interested buyers as the amount of bonds issued.

"I don't think fewer investors will buy Czech government bonds because they are among the safest in Europe," Prokop said. "But they will expect a higher return on their investment to make up for the added cost of insurance."

Emily Thompson can be reached at
ethompson@praguepost.com