The Greek Debt an analysis: level, creditors, banks and sustainability
This is the third installment in the in depth analysis of the Debt crisis in Greece/Eurozone. The last weeks it has been made clear that the stalemate in the greek situation is working to nobody’s favor. The word default has made headlines while the ECB and Germany are trying to broker a deal. In the previous post all the players’ incentives and strategies were analysed. This post will focus on the possible routes the situation can unfold.
Greece, the EU and the IMF are faced with three painful choices: No restructuring by extending loans to the future(fiscal transfers), voluntary restructuring(the case of the previous post) and Default( hard restructuring). Out of all the above scenarios most likely the voluntary restructuring will prevail. Before that to happen the EU and IMF must continue funding Greece in order to make up for the deficit in 2012.
An economist would declare Greece bankrupt. The ratio of Debt/GDP ratio is at 150%, which economically is unrealistic. Unfortunately economists(like at Blemilo) confuse their science with mathematics. Mathematics is pure and simple, 1+1=2. In economics there are other factors which can overcome numbers or their rationale. This is even more acute in the greek case. Economics crosses paths with politics(local and international), a currency union and many diverging players.
Greece’s problem is Europe’s problem. Europe shouldn’t have accepted Greece in their family at the first place. The fault lies with them not with Greece. Most debt is held by European governments and banks. The contagion will spread like a fire in a haystack. Ireland and Portugal will be consumed by the flames of bad debt spreading through Europe. The problem will require a solution made by the Europeans to fit the Europeans. Timing is also a factor that can make or break any deal. If all the players have coordinated their actions but not their timetables chaos can ensue. Events can derail the whole plan. The first danger is to find a solution to the increasing pile of Greek debt and Greece’s needs for 2012.
Greece will restructure its debt at some point, it cannot be avoided. When and how are two topics that require analysis. Greece will default when Europe tells her to. The default would be beneficial from an economic and political viewpoint. How much should the debt burden be reduced without eating banks’ capital? Will the system be safe from contagion? All these questions will provide answers to pressing matters.
To recap from the first post, Greece is incentivized to go down the road of reforms and shoulder the pain it has inflicted to itself. Greece’s default won’t spell Doom immediately for the other PIGS countries. The EU banking system is in good health. If the Greek public keep on protesting and resisting reforms then the chances for a good result are minimal. One should not underestimate the potential of Greeks to wreak havoc upon themselves.
When Greece received its bailout of 110€ billion from the EU and the IMF it was rested upon 2 critical conditions. Greece would tap the financial markets in 2012 and cut spending more than raise revenues. Greece was consistent on delivering its failure. First of all cutting spending(in Greece’s case cutting waste) is something that no party really believes in. The failure in controlling spending and the ensuing recession which resulted from a heavy tax burden make impossible for Greece to get funds in 2012. That year Greece will need 27€ billion according to the IMF’s predictions. This doesn’t include the deterioration in finances due to the recession and the new measures getting approved by the Greek Parliament. Greece has promised 50€ billion in receipts from privatization programs but no rational buyer would commit even modest amount in this climate of unrest and political upheaval.
The yield right now for Greek bonds is the juicy 20%. According to an investment bank Greece’s debt is sustainable(with a primary balance) at around 6%. At current levels Greece cannot issue any more debt at the international markets. At the same time European countries do not comprehend what will mean for a Euro country to default(even for a small one like Greece) and they rather not find out.Fear Greeks bearing bonds. According to the Greek agency responsible for debt the major holders of Greek debts are: Greece 29%, Europe 60% and around 11% the Rest of the world. As for what entities hold the debt: Banks hold 43%, Fund Managers another 22% and Insurance funds another 15%. Funds that hold trillion in assets will have hard times but the system will remain alive.
From an economic point of view the risk of contagion can be minimized, but the reader should always remember economics are also affect by market sentiments. When Greece defaults the market can have a very adverse reaction which can result in a Lehman times 3 situations. Therein lies the biggest black swan. European banks had more than 2 years to prepare for the Greek bust and have offloaded or written down their exposure. Unfortunately they are overexposed to Ireland. If Ireland joins the fray then the whole system might collapse. Irish officials know this danger and they are not allowing their banks to default.
Banks holding other bank’s debt and sovereign debt create a layer of interactions which offset the benefits that might accrue for any action. Spain might find it easier and cheaper to allow their banks to implode than to take on more debt to save them. Germany on the other hand can give money to Greece instead of facing the risk saving its financial system. The banks are aware of the politicians and how they distort plans with their words.
Greece faces another conundrum. While pre IMF-bailout its debt was under Greek law jurisdiction and any default would be handled by the Greek courts and their laws, definitely more appealing than international law. The IMF and EU loans though are made by official international entities and the rules for these deals are stricter and cannot be dictated by the debtor. The EU countries will detest any plan that saddles their taxpayers with losses. The private sector losses too are a thorny issue. The more Greece borrows from the IMF and the EU the more private lenders reduce their exposure while official lenders increase theirs. This alchemy of different mixes will require a bigger haircut(losses) for the debt to become sustainable.
But what is sustainable? IMF in 2010 suggested(remember the folly of forecasts?) that Greek debt will top at 159%(way past it now) and bring a primary balance of 6% in 2014. The growth would reach levels of 3% afterwards. According to the OECD Greece had a primary balance only from 1994 to 2001(Simitis’ “Golden” era) and that was a maximum of 4%. The author is not a wizard who can come up with a number or a formula for it. Maastricht’s treaty of 60% would be a good start but Greece needs to have a constitution that would bar deficits from forming. Unfortunately the author is certain that even if Greece can reduce its debt through a haircut, politicians will soon drive it up again.
It is sad that everybody in the world(at least in Europe) have woken up to the dangers of a Greek default. Europeans want to solve the riddle but they have no faith in Greeks. Greeks have again done their trick, absolved themselves of any responsibility and blamed everyone else except themselves. A striking example is the 2 main parties(which created the problem with their corruptive ways). In every other country where recession struck both the government and the main opposition agreed that spending cuts must happen. In Greece the CIO(Clown In Office) of the New Democracy has become Mr. NO, willing to see Greece default than save the country. Do not worry he has done again twice in the past and it worked to his favor.