European Union officials have made it clear talks about debt relief will start once Greece has honored the commitments under the economic adjustment program. Back in April, the Eurogroup also repeated its pledge to provide adequate support to the country, while German officials and others have left the door open for another small bailout loan to close the projected financing gap after 2014. But in calling on Greece to honor its commitments, many EU officials seem to have forgetten their informal commitment made back in November 2012 to fill the 11-billion-euro funding gap created in the program by the Greek bond buyback.
In its latest review of the economic adjustment program, the International Monetary Fund projects Greece’s gross borrowing needs will exceed gross financing sources by 12.6 billion euros in 2015 and will be even bigger in 2016. In calculating the financing gap, which opens after May 2015, the Fund has taken into account several factors. It includes the 3 billion euros raised by the sale of the five-year bond this year, projected intergovernmental borrowing of 3 billion euros, arrears clearance of 4.5 billion euros cumulatively in 2015-16 and the collection of privatization proceeds amounting to a total 5.5 billion euros in the next two years, from 1.5 billion in 2014. It also assumes the outstanding T-bill stock will remain unchanged at 15 billion euros annually over this period and the time schedule for the provision and repayment of EU and IMF loans will be adhered to.
German Finance Minister Wolfgang Schaeuble referred to this gap about three weeks ago when he reportedly said Greece will probably need a new aid package of up to 10 billion euros. This created political turbulence in Greece where bailout loans are associated with austerity measures. It therefore comes as no surprise the coalition government has made disengagement from the deeply unpopular economic program a priority as it faces the prospect of snap elections if Parliament fails to elect a new president at some point in the next eight months or so. The IMF’s latest estimate on the 2015-16 funding gap appears to be realistic although it could turn out to be bigger or smaller depending on the course of the economy and other factors, including Greece’s ability to raise more money from the markets.
Under normal circumstances, the EU bailout loans would be fully disbursed by the end of this year and the program would formally expire. Funding from the IMF will continue through the first quarter of 2016. However, something important is missing from the discussion about how to cover Greece’s projected funding hole in the next two years. This is the more than 11 billion euros of program funding front-loaded in December 2012 to finance the buyback of Greek bonds, with a nominal value of over 30 billion euros. The bond buyback resulted in the reduction of public debt by about 20 billion euros or 10 percentage points of the GDP and was part of an agreement reached by the EU and the IMF at the time so the latter continued to fund the Greek program.
According to a number of senior Greek government officials, high-level EU officials pledged at the time to find a way to pay for the 11 billion euros which opened a gap in program funding for which the country was not responsible. However, the ECB objected to the idea of rolling over Greek bonds held by the Eurosystem to fill the gap which has remained open ever since. As a matter of fact, the Greek authorities and the official lenders have taken steps to push the financing gap into the future, but this cannot continue for ever since the program will end sooner or later.
One way out would have been for Greece to use the 11-billion-euro bank buffer after the ECB’s asset quality reviews and stress tests in the fall. However, this assumes local banks will be able to cover any capital shortfalls identified by the ECB via other means, such as selling assets or raising additional capital from private capital. At this point, no one knows the outcome of the ECB’s stress tests nor the capacity of local banks to satisfy any capital requirements from other sources. Moreover, it is possible the ECB may ask for the whole or a partial amount be kept as a buffer till the end of the Greek program in 2016.
So, using the 11 billion euros or a smaller amount from the bank buffer remains in question. It should be noted the 11 billion is included in the country’s debt stock as far as debt sustainability analysis is concerned. That means if the amount is used for state financing, it will decrease the debt-to-GDP ratio by more than 5 percentage points and cut annual financing costs in the future. This would lower the Greek debt ratio below 124 percent of GDP in 2020 compared to 128 percent projected by the IMF in the latest review.
All in all, the EU is right in asking Greece to honor its commitments under the program to receive debt relief. However, Greece is also right in asking the EU to honor its informal pledge made in November 2012 and help close the 11-billion-euro hole created by the bond buyback. This way Greece would face virtually no funding gap in 2015-16 and it would help to avoid taking a new bailout loan, however small, which could have serious political implications.