Plenty of schemes are being floated for how Greece might secure relief from an unsustainable debt approaching 165% of GDP and likely, before long, to require an annual interest payment equivalent to 10% of GDP, mainly to foreign creditors. Costas Meghir, professor of economics at University College London, described this as an “annual blood-letting”, in a debate at the LSE last month with Herakles Polemarchakis, an economic adviser to the prime minister of Greece, and Nicos Christodoulakis, former Greek minister of finance and economy.
Meghir proposes an agreed restructuring of Greek debt to secure a 50% reduction of principal and an extension of remaining maturities. He suggests that to prevent Greece simply getting away with not paying its debts while avoiding painful reforms, the haircutted bonds should be exchanged into new instruments under English law, to be held by the EU, and progressively cancelled only as long as Greece continues with a pre-agreed economic reform programme. This would dismantle anti-competitive monopolies of tenure in many sectors of the economy. Failure to meet reform targets would result in bonds being resubmitted for full payment of principal and accrued interest.
Growing disagreements between the European Central Bank and European politicians on how to manage Greeces unmanageable debts threaten market turmoil ahead. In one important respect, Greece is already being treated as a defaulter. It is funded to 2012 but entirely priced out of the bond markets by the perception that prioritized repayment of EU and IMF loans will structurally subordinate private-sector creditors.
If there is any hope that Greece can get out of jail, it needs to score some big early successes on its 50 billion privatization programme. No market participants that Euromoney talks to hold high hopes for this.
EU governments might keep writing new cheques for Greece just to prevent a domino effect of other countries populations, also sick of austerity, forcing their politicians to seek debt forgiveness and a raft of sovereign defaults crippling the European banking system. But at some stage, it would seem inevitable that the countrys insolvency must be recognized and dealt with.
As a stern opponent of debt restructuring, the ECB is fighting against this like any big principal investor, any hedge fund or bond fund manager, would if caught long and wrong. Whether the ECB is acting in Europes best interests is another question.
The ECB has suggested that restructured Greek sovereign bonds would not be eligible as repo collateral. Is this a negotiating position? Many bankers now suggest that the ECB will eventually have to reverse track and allow banks to continue to hold reprofiled sovereign bonds at face value and use them as collateral for ECB funding. The ECB might even have to reverse its policy entirely and push banks into a voluntary restructuring by refusing to accept as collateral any untendered bonds.
It wont be easy, though, maintaining the fiction that reprofiled bonds have not suffered a huge loss of value. Fitch made it clear last month, when it downgraded Greeces issuer default rating to B+, that even this rating depends on further EU and IMF new money funding Greece beyond mid-2013 and on the avoidance even of a soft restructuring of existing debts. Any reprofiling will count as a default, Fitch says. Such clarity at least is refreshing.
Much depends now on the publication in mid-June of the fourth review of the EU-IMF programme for Greece. Structural reform of the Greek economy was supposed to restore growth and boost government finances. It has done neither yet. This is a worrying outcome for the eurozones most troubled sovereign borrower and the key test case for economic resuscitation under conditions of EU-IMF financial support.
Having contracted by 2% in 2009 and 4.4% in 2010, the Greek economy looks on course to enter the third year of its two-year recession and shrink by another 3.5% in 2011. For all the attention being paid to the unsustainability of the countrys finances, it is this lack of growth that is the more pressing issue. It offers little encouragement to other sovereign debtors pursuing fiscal austerity.
There is, of course, one way for Greece to regain external competitiveness, a way that would further increase the value of its already burdensome debts. It is surprising that there seems to be no political will in Greece to go down this road, given that these debts already look unsustainable anyway and ways to default on them are clearly being considered.