Messing up the next Greek debt relief could endanger the Eurozone

Charles Wyplosz, 23 September 2013

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The situation in Greece is so disastrous that some form of debt relief is likely. The timing is right as Germany’s electoral ‘purdah’ period has ended.

The most likely solution, however, will make it impossible to deal with other countries. Since the beginning, policymakers have invented “unique and exceptional” solutions to deal with Greece. But these went on to become the blueprint for subsequent programmes applied to other countries.

The Greek programmes haven’t worked

It does not take a math genius to observe that its economic situation has worsened since Greece entered into Troika programmes. The economic situation is horrible:

  • GDP has plummeted, and continues to contract to a total of 30% over the last six years of deepening depression (see the figure below).
  • The European Commission forecasted Greek growth of -4.1% for 2013, but it has been -5.5% so far this year according to the IMF.
  • The unemployment rate stands at 27%;
  • Youth unemployment is 57% (yes, that’s fifty-seven, not 5.7).

The financial situation is almost as bad:

  • At the end of 2009, on the eve on the crisis, Greek gross public debt stood at 130% of GDP, now it is 175%.
  • Bank deposits have fallen by 30%, partly fleeing abroad, partly the result of strong dissaving by the population.
  • Nonperforming loans to households and corporations have reached the amazing levels of 25% and 31%, respectively.

Officially, most of the banks have been recapitalised, but these nonperforming loans are on their balance sheets.

Figure 1. Quarterly real GDP, SA (billions of 2005 euros)

Source: IMF.

Piling up disastrous statistics is just too easy. At any rate, such numbers fail to describe the human tragedy that is under way. The rosy forecasts of official institutions do not even begin to address the massive policy failures at the root of this tragedy.

Human tragedy from a reluctance to face reality

The ‘IMF apology’ published last June states that: “the Fund approved an exceptionally large loan to Greece under an Stand-By Arrangement in May 2010 despite having considerable misgivings about Greece’s debt sustainability. The decision required the Fund to depart from its established rules on exceptional access. However, Greece came late to the Fund and the time available to negotiate the programme was short. The euro partners had ruled out debt restructuring and were unwilling to provide additional financing assurances.” (IMF, 2013, p.32)

  • Worse, maybe, we are still facing the exact same reluctance to face reality and put the crisis behind us.
  • Worst of all, the decisions likely to be taken now that the German elections are over will make it nearly impossible to deal with the crisis elsewhere, repeating a familiar pattern.

Face reality: Send Greece to the Paris Club

Today, the Greek government’s debt stands at some €320 billion. The total value of loans provided by European governments and the IMF amounts to €200 billion, of which some € 176 billion has been disbursed (European Commission, 2013). In addition, the Eurosystem’s loans amount to €85 billion.

This means three things:

  • First, 'help' from Europe to Greece has been the most important contributor to the debt pile up since the beginning crisis.

The debt has been reduced by some €60 billion in 2012 through the Private Sector Involvement (PSI) programme, but the bulk of the losses were borne by Greek banks, which have had to be subsequently recapitalised.

  • Second, Greece simply cannot recover steady growth under the accumulated debt burden.

Even if there are doubts about the Reinhart and Rogoff (2010) result that debts above 90% of GDP choke growth off, Greece and some other countries are largely above this threshold. Large debts impose a heavy debt burden and make debt dynamics highly unstable, as the last four years of austerity-cum-debt-buildup powerfully illustrate.

  • Third, most of the Greek debt is now in official hands.

The fear that restructuring would destabilise banks around the world – mostly in European core countries – has now disappeared. Greece is a natural candidate for a Paris Club agreement – the long-standing informal group of official creditors that seeks to find coordinated solutions to debtor nations' payment difficulties (Weiss 2012).

From PSI to ‘OSI’: Official debt restructuring

In fact, policymakers have signalled their understanding that some debt restructuring will have to take place.

  • IMF (2013) notes that “debt is expected to decline to 124% in 2020, after additional contingent relief measures of about 4% of GDP from Greece’s European partners to be determined in 2014–15.
  • In addition, European partners committed to reduce debt to substantially below 110% of GDP in 2022, if needed and conditional on Greece meeting its commitments under the program” (pp. 11-12).

This quasi-decision has been kept under wraps because of the German elections, but it is bound to come to the fore now.

This ‘contingent relief’ will be presented undoubtedly as yet another 'unique and exceptional' policy. But it cannot be. Other countries will also need relief: Portugal for sure, Italy too, Spain perhaps. For this reason, the move must be done in such a way that it can be reproduced elsewhere, even for large countries.

Towards a more systemic approach

Debt restructuring can be achieved in many ways.

  • Debts can be reduced explicitly through swaps or write-downs.
  • They can be lengthened at favourable interest rates.
  • They can be exchanged against shares or contingent bonds, as with the Brady bonds successfully used in Latin America in the 1980s.
  • They can be monetised.

This technical aspect matters because it affects the magnitude of the debt relief.

The IMF mentions a debt relief of 4% of GDP. The last Greek sovereign-debt write-down – euphemistically called ‘Private Sector Involvement’ – wrote down some 30% of GDP. That was painfully inadequate. Post-relief debt should ideally be of some 50-60% of GDP. With a debt of some 175% of GDP, a 4% reduction is not meaningful – even at symbolic level.

Of course, debt restructuring can and should be accompanied by asset sales but – as argued in Pâris and Wyplosz (2013) – this can only take care of a moderate portion of the adjustment. Similar numbers apply to the other highly indebted countries.

  • The implication is that the 4% target is not just unrealistic for Greece.

Moreover it establishes a flawed norm that is likely to keep the crisis going for much longer.

Stronger medicine is needed

Debt rescheduling can easily wipe out 4% of GDP worth of debt. The much larger relief that is needed requires more powerful instruments.

  • Crucially, the Greek debt is small, totalling slightly more than 3% of Eurozone GDP.
  • Policymakers will naturally tend to treat any debt relief in a way that makes it hardly noticeable.

The Italian debt is equal to 20% of Eurozone GDP, so 'clever' arrangements that slip under the bridge will not do.

  • This means that, one way or another, there will have to be some debt monetisation, as explained in Pâris and Wyplosz (2013).

Greece is a good place to start, if only because it is so small.

Conclusions

People rightly worry about moral hazard. They oppose any debt restructuring on the ground that it would only encourage Greece and other countries to borrow more, rather than putting their houses in order.

In fact, a debt restructuring would solve a completely different moral-hazard problem – the tendency of the stable countries to ‘kick the can down the road’ by forcing crisis countries to borrow rather than restructure their debts early on, when they are smaller.

Fiscally undisciplined countries have been severely punished over the last few years. The time has come for the 'generous' official lenders to face the consequences of their short-sighted approach. This is the bad news that Chancellor Merkel ought to break now to her people.

References

European Commission (2013) “The Second Economic Adjustment Programme for Greece, Second Review”, European Economy, Occasional Papers 148. May.

IMF (2013) “Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement”, IMF Country Report No. 13/156.

Pâris, Pierre and Charles Wyplosz (2013) “To end the Eurozone crisis, bury the debt forever”, VoxEU, 6 August 2013.

Reinhart, Carmen M., and Kenneth S. Rogoff (2010) “Growth in a Time of Debt” The American Economic Review 100(2): 573–78.

Weiss, Martin A. (2012). “The Paris Club and International Debt Relief”, February 17, 2012, Congressional Research Service, www.crs.gov.

Topics: EU institutions, Macroeconomic policy
Tags: debt rescheduling, Greek debt

Professor of International Economics, Graduate Institute, Geneva; Director, International Centre for Money and Banking Studies; CEPR Research Fellow