Friday, 9 December 2016

Analysis: The meaning of Greece’s partial debt restructuring

This month’s meeting of Eurozone finance ministers, or Eurogroup, approved debt relief measures for Greece that had been floated in May. At that time the proposals were contingent on Greece passing its first assessment under its third bailout loan, which it has now done.

The measures do not ultimately render the debt sustainable, but they represent the first important restructuring of Greek debt held by other European sovereigns. In that sense, the Eurogroup can be said to have passed a political milestone on a long maturing process that will hopefully see further measures. The ultimate goal of Greece’s bailout, after all, is to tide it over while it overhauls is uncompetitive economy, until it is able to borrow from the private sector again. Markets may be happy to lend to highly indebted economies with strong exports (Japan, US, Italy), but the Greek economy is not robust enough to warrant such treatment. 

What are the latest measures?

The December 5 Eurogroup approved three proposals by the European Stability Mechanism – the Eurozone’s distress fund for sovereigns - which currently holds €162bn of Greece’s €320bn debt, and will hold roughly €200bn of it in 2018. It is therefore the indispensable creditor:

1.     Steady rate of repayment: Greece still owes €131bn from its second bailout loan, which matures in 28 years. This will be extended to 32.5 years. The effect of this extension is that Greece will pay a bit more in interest, but it will face no “repayment humps” – years in which its annual premium is set to rise  sharply.
2.     Steady rate of interest: Greece’s first and second bailout loans carry a floating interest rate. That is fine in the current environment, where the European Central Bank’s base rate is zero. This has enabled Eurozone countries to lend to Greece at rates, which now average below two percent; but market conditions could change over the next 32.5 years, so the ESM will alleviate that risk by swapping Greece’s floating rate bonds for fixed rate bonds in order to lock Greece into current, low market rates (the precise rate is subject to a negotiation between Greece and the ESM). It will also offer any future loans to Greece on this fixed rate. In this way, the ESM acts as a shock absorber between Greece and the market.
3.     No stepped-up interest rate: Greece’s second bailout entailed an interest rate step-up of two percent for debt buy-back. This would start being charged in 2017, but is now being scrapped, at a cost of about €200mn to European taxpayers.

What these measures will ultimately do for Greece’s debt sustainability is not certain, but ESM chief Klaus Regling thinks they will lower Greece’s debt-to-GDP ratio by roughly 20 percent between now and 2060.

Is this enough?

No one is pretending that this is a breakthrough. Greek Finance minister Euclid Tsakalotos called the Eurogroup “intriguing and interesting” and its result “very promising”. Regling stressed that these are only short-term measures, and that anything more ambitious will have to wait until mid-2018, when Greece’s current bailout period ends. 

If anything, Greece has been reminded of an onerous undertaking in the Eurogroup statement, which recalls that, “the primary surplus target of 3.5 percent of GDP reached by 2018 should be maintained for the medium-term.” This means that Greece has committed to setting aside a sum equal to 3.5 percent of its economy with which to repay debt in 2018 (it is set at 1.7 percent for next year), and creditors expect it to continue to bleed its economy at that rate for several years thereafter. No one has said exactly how many years Greece will be asked to do this, but off-the-record estimates vary between three and ten.

This is a problematic premise. In its debt sustainability analysis last May, the International Monetary Fund said it didn’t think Greece could achieve the 3.5 percent level without politically impossible sacrifices. It confirmed that view on December 5.

Furthermore, the IMF said in May, “Even if Greece through a heroic effort could temporarily reach a surplus close to 3.5 percent of GDP, few countries have managed to reach and sustain such high levels of primary balances for a decade or more, and it is highly unlikely that Greece can do so considering its still weak policy making institutions and projections suggesting that unemployment will remain at double digits for several decades.” Instead, the IMF said, creditors should work on the assumption of a primary surplus of “no more than 1.5 percent of GDP”, this lying in the IMF’s view “within the realm of what is plausible”. 

This analysis is based on the fact that Greece’s political elite is now provably pitted against a fast pace of reform, and its banks so overburdened by non-performing loans that they won’t be able to finance much new business. Growth is therefore bound to be sluggish – as indeed it is in the Eurozone as a whole.

So what is the IMF’s proposed solution?

All of the measures the Eurogroup adopted this month are based on the IMF’s May proposals, but they are partial implementations. For instance, the IMF proposed that Greece’s first and third bailout also be included in the extension of the repayment period (another €113bn). Regling’s proposals extend only the second bailout (131bn). The IMF also proposed low, long-term, fixed interest “not exceeding 1.5 percent”. The goal, the IMF said, was to achieve a 50 percent fall in debt-to-GDP ratio by 2060 if Greek debt is to be considered sustainable, not the 20 percent fall Regling says will suffice for now.

Why has the ESM chosen to focus on the short-term relief instead?

Syriza did attempt to redefine Greece as insolvent, rather than just illiquid, in its first six months in office. In other words, Syriza said Greece needed an overhaul of its finances, including generous debt forgiveness, rather than constant cash injections that keep its economy alive but bedridden. This attempt famously failed, because under German leadership the Eurozone does not want to spend-and-stimulate its way out of members’ sovereign debt crises, but encourage them to save their way out, hence the policy of austerity.

Regling rejected the importance of the debt-to-GDP ratio in an interview with the Financial Times in October last year: “Mr. Regling’s argument is that Greece’s debt should be measured by what Athens currently has to pay on an annual basis rather than the overall stock of debt,” the FT wrote. “He insists [that] private investors – who must ultimately replace bailout lending – care more about such “debt flows” than the overall debt levels.”

This is the guiding principle of the ESM’s short-term measures - that Greece’s nominal debt ultimately doesn’t mater, only its ability to service its debt, and the ESM is prepared to lend Greece just enough to achieve the latter. But this logic goes against the founding principle of austerity, which is to bring Eurozone economies back in line with the terms of the Stability and Growth Pact. That allows a debt-to-GDP ratio of no more than 60 percent. 

Greece has had to accept that what Regling and Berlin say, with all their contradictions, is the reigning logic in Europe. During his annual keynote speech on the economy at the Thessaloniki International Fair last September, Prime Minister Alexis Tsipras didn’t even mention debt restructuring as a national priority. Instead, he talked of Greece’s one day being included in the European Central Bank’s quantitative easing programme. 

Under Regling’s proposals, Greece will try to lock the €131bn it owes under its second bailout into a low interest rate of, say, just over one percent. That will represent one of the lowest rates of interest it has ever paid. It's a start. It may be that this softer approach to a debt deal is producing better results than Syriza’s high-profile, head-on approach during its first six months in power. But unless Germany ultimately agrees to a fuller debt restructuring, these interim measures will be pointless and expensive to the Greek taxpayer. The IMF and the Eurogroup agree that at present, Greece's debt will be around 250 percent of GDP in 2060. 

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