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 programs 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 per cent over the last six years of deepening depression (see the figure below); the European Commission has forecasted Greek growth of -4.1 per cent for 2013, but it has been -5.5 per cent so far this year, according to the IMF; the unemployment rate stands at 27 per cent; youth unemployment is 57 per cent.
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 per cent of GDP, now it is 175 per cent. Bank deposits have fallen by 30 per cent, partly fleeing abroad and partly the result of strong dissaving by the population. Nonperforming loans to households and corporations have reached the amazing levels of 25 per cent and 31 per cent 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)
Piling up disastrous statistics is 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”.
Worse,perhaps, that 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 ($A458.93 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. 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 result that debts above 90 per cent 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.
From PSI to ‘OSI’: Official debt restructuring
In fact, policymakers have signalled their understanding that some debt restructuring will have to take place. The IMF notes that “debt is expected to decline to 124 per cent in 2020, after additional contingent relief measures of about 4 per cent 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 per cent of GDP in 2022, if needed and conditional on Greece meeting its commitments under the program”.
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; and 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 per cent of GDP. The last Greek sovereign-debt write-down — euphemistically called ‘Private Sector Involvement’ — wrote down some 30 per cent of GDP. That was painfully inadequate. Post-relief debt should ideally be of some 50-60 per cent of GDP. With a debt of some 175 per cent of GDP, a 4 per cent reduction is not meaningful, even at a symbolic level.
Of course, debt restructuring can and should be accompanied by asset sales, but 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 per cent target is not just unrealistic for Greece, but that 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 per cent 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 per cent 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 per cent 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.
Greece is a good place to start, if only because it is so small.
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 to her people.
Originally published on www.VoxEU.org. Reproduced with permission.