Last week, Eurogroup finance ministers in their wisdom decided that there would be no debt relief or restructuring for Greece until the end of the summer. Evidently they wish to avoid exciting voters in the European Parliament elections in May. This is regrettable, since it only puts off the inevitable and forces the Troika to use smoke and mirrors to fill the government’s funding gap.
Moreover, what is currently on the table – stretching out the duration of Greek government bonds held by the ECB and ESM and lowering the interest rate yet again – will make only a small dent in the country’s debt. Stretching out maturities and reducing interest rates will not speed privatisation, nor will it encourage foreign direct investment. It will do nothing to foster growth.
The problem is that Greek policymakers must rely on deflation rather than currency devaluation to adjust prices and wages. Deflation is an anathema to long-term investor confidence, however, and the slow pace of relative price adjustment makes robust recovery difficult. In sovereign debt crises past, currency devaluation has been used to jumpstart growth and attract foreign investment. But devaluation is not an option for Greece.
An alternative approach involving debt-for-equity swaps would address all of these problems at a stroke.
- The ECB, ESM and EU should commit a portion of their holdings of Greek government loans and bonds to a swap facility.
- Private investors interested in purchasing government assets could then buy loans or bonds with a face value of €1,000 for, say, €500.
- The Greek government, for its part, could agree to accept those bonds as currency for, say, €750 when selling government property at auction.
The government is happy in this scenario because it effectively extinguishes its debt at a 25% discount (the difference between the €1,000 face value and the €750 value investors receive). Investors are happy because they pay only €500 for €750 worth of newly privatised assets. The ECB should be happy as well since it purchased its Greek bond portfolio at a discount, limiting the losses it takes on this transaction, and since it can now take an early exit.
The ESM, meanwhile, will be able to liquidate some of its loans to Greece without incurring additional losses because it has already lowered interest margins and fees and extended maturities on most of them. These loans already have a low fair market value of, at most, 50 cents on the euro.
Incentivising new investments
Besides enabling Greece to cancel large parts of its remaining debt and giving the official sector a graceful exit, debt-equity swaps create powerful incentives for new investment. Swaps like those we’ve outlined, by embedding discounts on both sides of the transaction, would enable Greece and the EU to use these debts much like a currency to adjust relative prices and subsidise investment in the Greek economy.
The swap could also be structured to appeal to foreign governments and NGOs. For example, it could be structured as a debt-for-clean-energy swap. The Greek government would commit to sell of publicly owned land that could be used in constructing solar farms by German utility providers, thereby addressing that country’s clean energy needs.
Alternatively, a debt-for-environment or debt-for-nature swap facility could allow private groups and NGOs to purchase government-owned land and set it aside for conservation. A religious charity could swap debt for arable public land to be used not just for conservation, but also for sustainable food production for low-income groups.
Debt for equity swaps like these have been used before.
- Starting in 1987, Chile retired debt to the money centre banks through debt-for-equity swaps that financed investment in its forestries.
- In 1988 the WWF purchased $400,000 of Philippine debt at 51 cents on the dollar in return for the government investing a commensurate amount in conservation projects.
- In 1992 the government of Ecuador swapped some of its debt to money centre banks to Harvard for use in funding studies in that country by the university’s students.
Debt-for-equity swaps would be easier to implement in Greece than in the 1980s Latin American context. In Latin America, governments had to convert the foreign debt purchased by investors into domestic currency before it could be swapped for local currency denominated equity. The central bank typically just printed that currency, increasing the money supply and fanning fears of inflation in what was already an inflationary environment. Inflation risk thus discouraged the authorities from pursuing swaps on a substantial scale.
A debt-for-equity swap for Greece would be free of this complication, since there would be no currency conversion involved, only euros. There would be no monetary emission, since the debt would be swapped directly for public assets. And if the influx of foreign investment stimulated demand and price increases in Greece, this would be all to the good given the deflationary backdrop.
There was also the worry in Latin America that swaps that retired a portion of the debt would only drive up the market price of the residual stock, leaving the effective burden unchanged. Here Greece has the advantage that the bulk of its debt is not actively traded. It is in the hands of the ECB and other official bodies, which can value it as they please.
Greece needs debt reduction. It will get debt reduction by the end of the summer if not before. But rather than offering another mindless lengthening of maturities and reduction in interest rates, Europe should use the occasion to encourage foreign investment, speed privatisation and jumpstart the Greek economy. Debt-for-equity swaps are the way.