With Greece obtaining the approval of a majority of private sector investors to renege on part of its debt, policy makers across Europe have been quick in expressing their optimism. We have seen several statements testifying to this such as: ‘the light at the end of the tunnel is now closer than before’/‘the worst of the crisis is behind us’/‘this is the end of the Greek crisis’.
Much as we would like these statements to be true, a closer look at the details of debt restructuring reveals worrying trends and conclusions.
Confusing debt numbers
The absolute numbers of the Greek restructuring exercise are certainly impressive: a volume of 206 billion of Greek sovereign bonds, currently owned by private sector investors, will be restructured and it is claimed that in this process, 110 billion worth of debt or 40% of GDP will be scrapped.
However, this operation is not just limited to eliminating existing debt obligations. It is also about transforming existing debt into new and different forms of debt. Based on a variety of sources, the following picture can be drawn:
- On the one hand, as stated, 206 billion worth of sovereign debt bonds held by the private sector will be done away with.
- In return however, Greece will subscribe to new forms of debt:
- Greece will pay back to the private sector investors 15% of the amount originally borrowed, in cash. To do so, she will turn to the European Financial Stability Fund (EFSF) and borrow an additional 30 billion from it. (In practice, private sector investors will not be paid in cash but in bonds issued by the EFSF with Greece paying debt and interest service to the fund).
- A further 32% of the face value of old debt (66 billion) will be transformed into new debt obligations which Greece will hand over to private creditors. These new Greek bonds will have a maturity of 11 to 30 years. They are backed up by multiple anti-default mechanisms: by issuing them under British law, investors will enjoy increased protection against a possible future default. Moreover, Greece will borrow an additional 35 billion Euro from the EFSF and put this additional finance up as a guarantee for the 66 billion worth of newly transformed private sector debt. The European Council actually calls this debt restructuring ‘sweeteners’.
- Because the restructuring of sovereign debt is also hitting the Greek banking system, Greece will undertake yet another loan of 25 billion from the EFSF so as to recapitalize its banks.
Adding all these figures up leads to the conclusion that Greece actually has to subscribe to 156 billion worth of new debt in order for 206 billion worth of old debt to be written off. The figures being mentioned everywhere on a write down of 110 billion worth of debt are therefore not entirely accurate. In gross terms, only some 50 – and not 110 – billion worth of sovereign debt are to be scrapped.
Too limited to deal with the tsunami of debt dynamics
Even if debt relief of 50 billion or 20% of GDP is substantial on its own, it provides little relief when the overall debt dynamics of Greece are taken into account.
Consider the following numbers: Greece entered 2012 with a debt position of 162% of GDP and a 2011 deficit of 9% of GDP. The Troika’s idea is to squeeze the deficit further down to 5% in 2012 through a harsh austerity program. Even if this is successfully implemented, debt would still increase and reach about 170% of GDP by the end of 2012: the remaining deficit (5%) would translate directly into additional debt. At the same time, the fall in nominal GDP (a 3% drop in real economic activity with a 0.2% inflation rate in 2012) will pull the denominator of the debt ratio down, thereby pushing up the debt ratio itself.
In the end, all that the restructuring operation is able to do is to push debt down from 162% to 150% of GDP instead of allowing it to explode to 170%. This however only constitutes a temporary reprieve since a level of 150% is still very vulnerable to a renewed explosion of debt dynamics.
Explosive debt dynamics set to continue
Indeed, interest needs to be paid on this debt of 150% of GDP though is not clear exactly what rates will be charged on the new debt bonds. However, if we work on the basis of IMF data reporting a 4% average implicit interest rate on Greek sovereign debt, then the Greek state will need to pay an annual interest rate bill of 6% of GDP, which is about twice as much compared to other Euro Area member states.
In other words, each year the outstanding volume of debt will automatically be pushed up by an amount of 6% of GDP. Even if nominal growth does, eventually, return to Greece to provide a positive denominator effect (say, for example, 4% nominal growth), the debt ratio will still continue its upward path (although the pace would be reduced to 2% in this example). And, if (as is very likely) additional fiscal austerity is implemented over the course of the next few years, this positive denominator effect that stems from nominal growth will not be present. In all likelihood, debt in Greece will edge back up to levels close to or even higher than 160% of GDP.
The real success story behind the headlines: private ownership of debt becomes public ownership
The program of fiscal austerity and social deregulation which the Troika continues to impose on Greece is a failure: it has thrown the Greek economy into a prolonged state of recession, and has thereby contributed to a higher sovereign debt burden.
The debt restructuring which the European Council is now offering is insufficient: it is limited to providing short and temporary relief without breaking the powerful debt dynamics resulting from a still excessive sovereign interest rate bill as well from the persistent depression that is caused by the implementation of mindless fiscal austerity.
However, from the perspective of protecting the creditors’ interests, the Troika’s policy can be qualified as a relative success: over the course of the past two years, private sector creditors have been able to massively offload Greek sovereign debt from their balance sheets and shift the risk towards public sector agents instead.
Indeed, at the onset of the Greek sovereign debt crisis, the entire stock of 300 billion worth of debt was in private sector hands, with financial institutions outside of Greece holding a substantial part of it. Now, two years later after: two Troika bail outs, the ECB buying up distressed sovereign debt and this new debt operation involving the private sector, the share of debt held by the private sector is down to 60 billion out of a grand total of 300 billion worth of remaining Greek sovereign debt. As described above, 60 billion worth of private sector-held debt is now benefiting from enhanced guarantees. The rest, some 240 billion, is now in the hands of the EFSF, the ECB, the Commission and European member states (see graph below). The latter implies that if (when?) Greece defaults in future, it will be the official sector that will take the full blow. This is all the more reason why the Troika and the European Union urgently need to abandon their IMF-type structural adjustment approach and replace it with a real plan for Greek economic and social recovery.