It is a common opinion among investors and policy makers that the reduction in Greek private debt earlier this year was insufficient. A few months after private investors agreed to write down the value of their bonds, Athens’ debt to gross domestic product ratio is rising rapidly towards 200 per cent again.
The conclusion seems to be clear: private sector forgiveness is not enough to achieve a sustainable debt. That portion of Greek debt held by European governments and institutions such as the European Central Bank will have to be reduced too. In the jargon, OSI (official sector involvement) must follow PSI (private sector involvement).
The International Monetary Fund has taken this line but met resistance from the European Central Bank and the European Commission, its partners in the so-called troika negotiating assistance for Athens.
It should come as no surprise that the ECB and European Commission do not share the IMF’s perspective. When the IMF calls for OSI, it is in reality asking its partners in the troika to give up part of their claims, while the fund’s remains untouched, since its claim is 'super-senior' in any event. The IMF would actually benefit from OSI (of the others) because the Greek government would be in a position to repay its loans earlier. And it stands to benefit from any deal, given that during the lifetime of the programme under discussion its net exposure would fall, while that of its troika partners increases.
But disregarding the different self-interest of the official creditors, the fundamental issue remains: is Greek debt sustainable? The debt ratio says no but if one looks at the interest payments the Greek government has to make, the picture looks quite different. For the next few years, Athens is committed to interest payments of about 5.5 per cent of GDP a year, hardly unbearable. In fact, under current plans the Greek government would spend less on interest than it did during the first few years after it joined the euro. Then – in the 2001 fiscal year – payments on government debt were about 7 per cent of GDP.
By 2014, Greece’s interest burden is forecast to increase to about 6 per cent of GDP. But this would only bring it in line with Italy and Ireland – which will then devote a
similar amount of national income to debt service, even though the debt to GDP ratio of both countries is much lower than Greece’s – 'only' 120 per cent.
The reason is simple: the Irish and Italian governments pay market interest rates of, on average, about 4.5 per cent, compared with the 3 per cent that Greece pays on its, mostly official, debt. It is difficult to argue that the debt burden is not bearable for Greece if at the same time the governments of Italy and Ireland are expected to spend about the same percentage of their own national income on interest.
So what matters more for Greece: a debt to GDP ratio nearing 200 per cent or an interest burden of 'only' 5-6 per cent of GDP? The answer depends on the maturity of the debt. For the next few years Greece will not be in a position to repay much principal. Nor will it be able to refinance any debt in the market. The official creditors will therefore have to be patient, and extend the duration of their low-interest loans.
It is possible for the official creditors to show such patience because their own refinancing costs are low. The eurozone’s rescue mechanisms – the European Stability Mechanism and the European Financial Stability Facility – can finance themselves for very long terms at a lower interest rate than the one charged to Greece.
But would such patience be rewarded? It probably would be, as one can expect substantial growth in Greek GDP. Even if one does not believe that the structural reforms now being undertaken will increase growth in the long run, one should still expect a substantial rebound from the present excessively depressed conditions in the country. Greek GDP has fallen by about 20 per cent from its peak in 2008 and the European Commission estimates the gap between potential and actual GDP is now 14 per cent, meaning substantial growth over the next decade or so is likely. Over the next 10 to 20 years the average growth rate of Greek nominal GDP is likely to be higher than the interest rate the government pays on its debt, satisfying a key condition of debt sustainability.
All in all, there seems to be little need for another haircut on Greek debt. But the official creditors might have to wait some time before they get their money back.
Daniel Gros is director of the Centre for European Policy Studies.
Copyright the Financial Times 2012. Republished with permission.
Why Greece does not need debt forgiveness
Greece's gross debt has been rising towards 200 per cent of GDP. But with lower interest payments than Ireland or Italy, further assistance is unfair.