Wednesday, 25 January 2012

Greek Debt Crisis - Key Issues and Likely Outcomes

After the festive break, we’re back in action…and deja-vue… its Greece again.

The issues are now a little clearer but the political economy issues remain stark.
  • Greece is due to make a €14.4bn debt repayment by March 20th. It is unable to make this payment without external support.
  • The latter involves “burden sharing” to help solve Greece’s financing gap: (i) further debt restructuring of Greece’s external liabilities through an effective write-off of approximately €100bn of its €350bn public debt and (ii) external support from the IMF and the EU.
Will a deal with the private holders of the debt – under the aegis of the Institute for International Finance – be reached in time to avoid another D-Day calamity? Short answer, yes!

A co-operative arrangement for a debt restructuring is the preferred option for all parties - the creditors, the EU (and IMF) and Greece. For the creditors, precedents are being set for possible replication later in Cyprus and Portugal at the very least for the debt write-offs. The EU wants to avoid a spillover from a disorderly default onto the other peripheral economies as well as further impact on already dicey banking sectors and a fragile real economy. Greece doesn’t want to be the relegated from Europe, be shunned by the markets (although there’s plenty of evidence in the last 50 years that markets have short memories…), face a real bank run or lose access to EU-transfers and the current soft aid it’s receiving……and the likely ex-post likelihood this could in effect lead very quickly to an all out socio-economic collapse, hyperinflation, even a possible military coup and probable need for emergency outside support and finance.

The basic parameters of the deal have been agreed in terms of the write-off and the sticking point is now the interest rate on the swapped bonds: 3.5%, 4% or something in the middle. Brinkmanship may delay the decision but not the outcome. A lower interest rate will of course mean a higher reduction in terms of Net Present Value of the existing debt load for existing bond-holders.

Will all bond-holders agree to the outcome? Probably not and this may well lead to a technical default as far as rating agencies are concerned but – particularly if some holders refuse to accept the offer and which in turn leads to de facto non-payment to those who continue to hold existing paper. But then again those who didn’t settle still hold Argentine paper from its sovereign default in 2002 so this is not a killer point.

Will a “credit event” occur that triggers CDS payments? Again unlikely given the importance given in the EU to avoid contagion. Such an event would typically occur if there was a disorderly default (very low probability) or if there were holdouts by some bond-holders that in turn leads to a change in Greek legislation that effectively legitimises – at least in Greece – the switch to the new bonds (low probability).

The Greek Tragedy is alas exactly that…the economy is in a tailspin and shrank 6% in 2011 and isn’t expected to return to growth until 2020. Debt sustainability (120% of GDP is the magic target ratio under discussion) is only feasible over the medium-term if the country is able to at least grow in nominal terms as fast as the debt service….else.. as being currently grasped in the UK, austerity alone can actually lead to higher debt ratios if the economy contracts or grows at a rate lower than the debt interest rate due. i.e. the focus has to be on growth-enhancing policies.

Will this Private Sector Initiative or PSI in Greece coupled with another likely €130bn aid package from the official sector be it and deliver this path to nirvana? Probably not....

And this takes us back to the real questions and policy issues that require address….does Greece have genuine “ownership” for the structural adjustment it is being asked to implement and if not what incentive measures are feasible, if any...what will it REALLY cost - over and above the current and pending financial packages and debt reduction under discussion …..and what does it therefore say about the current and putative EU architecture for economic convergence and fiscal co-ordination….(next blog/s!)

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