The deal to cut Greece’s debt might be underestimated

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After each move from eurozone policymakers, the sceptics come out with the verdict: it won’t work. But what if, with the latest deal to cut Greece’s debt, this time it really is different?

Last week’s deal to cut Greece’s debt was quickly shot down with the usual remarks that it was “not enough” and only illustrated more “can-kicking” down the road.

After more than two years of hesitation on how to sort out the Greek debt crisis and after allowing it to engulf other eurozone countries, it is understandable that any initiative by policymakers in the single currency area is met with scepticism.

However, the sceptics might have underestimated the deal’s positive points. Indeed, its ground-breaking significance might have been overlooked.

It wouldn’t be the first time this kind of thing has happened.

In the winter of 2011, when the European Central Bank (ECB) for the first time pledged to throw unlimited amounts of cheap, three-year loans to banks under its two Long-Term Refinancing Operations (LTROs), the markets’ first reaction was dismissive.

At the time, the move was characterized as no more than kicking the can down the road and it was predicted not to have a substantial impact on the markets.

It was only a few weeks later, when it became obvious that banks were using the LTROs to support their balance sheet but also to buy higher-yielding eurozone debt, that the LTROs’ (ephemeral) splendor was recognized and markets cheered up.

Besides the technical aspects, another factor contributed to markets’ renewed confidence after the LTRO announcement: the shift in the ECB’s attitude towards providing liquidity.

Generally, before the three-year operations, LTROs were finite in terms of the amounts offered and maturities were shorter. The two LTROs signalled that the ECB was beginning to consider providing “unlimited” liquidity as needed.

The recent deal to cut Greece’s debt might be such a moment. Only a few months ago, taking a loss on Greek debt seemed something only the private sector could do.

Last week’s deal, however, shows that the attitude has changed: interest rates were cut or had the payment postponed, the maturities of certain loans were doubled, eurozone countries promised to give back to Greece the profits they make on Greek bonds their national banks bought from the markets, and Greece was allowed to buy back part of its debt.

A few months ago, such measures were opposed by many in the single currency area as amounting to financing another member’s debt, which is forbidden under the European Union Treaty. The fact the Eurogroup agreed on them now shows tremendous progress in terms of willingness to compromise.

 
 Source: Reuters
Another positive signal is Angela Merkel’s softening of the tone on a “haircut” on Greek debt when she said in an interview with Bild newspaper that this would be possible – but only if the country posts structural surpluses in its primary budget and only in 2014 or 2015. In other words, after the German elections.

However, the most positive signal might still come. On Friday at 5pm, a deadline expires for bondholders to sell back to Greece their holdings and help the country cut its debt further.

Greece will use around €10 billion ($13 billion) to buy back bonds maturing between 2023 and 2042, at prices slightly higher than mentioned in the Eurogroup’s press release, to attract sellers.

A successful auction would not necessarily herald the sudden end of the country’s troubles and a return to the heady days before the financial crisis, but it would be a visible light at the end of the tunnel for the eurozone debt crisis – which will still take years to truly get sorted.

Keep your eyes on the auction. If it is a success, maybe the ranks of the sceptics doubting a sustainable solution for Greece’s debt will become thinner.

Antonia Oprita is managing editor at Emerging Markets.