Greece should restructure debt, says Brussels think tank

BRUSSELS – A leading Brussels think tank has recommended that Greece should restructure its public debt as soon as possible, and that this should be one of the main elements of a comprehensive response to the eurozone crisis to be agreed by European Union leaders when they meet next month.

In a policy brief published on Monday, the Bruegel think tank argues that Greece is ?clearly on the verge of insolvency? and that the swift restructuring of its debt, with creditors accepting a 30 percent ?haircut,? should form part of a three-pronged strategy that includes the strengthening of the eurozone banking system and policies to foster greater growth in member states with weak economies.

The Greek government has consistently denied that it intends to restructure its debt but Bruegel?s most optimistic forecast indicates that with Greece?s debt-to-GDP ratio scheduled to reach 150 percent this year, an adjustment of ?frightening magnitude? in the country?s growth rate and cost of borrowing would be needed to avoid restructuring.

?If you look at realistic scenarios and at history, then it?s very unlikely that Greece can avoid restructuring its debt,? Zsolt Darvas, one of the report?s co-authors, told Kathimerini English Edition. ?It would be a very sad end to the first decade of the euro area but if something is not sustainable and you try to muddle through then the outcome could be worse for everyone involved, including the Greek government, the Greek people, Greek banks and creditors.

?So it would be preferable to have a solution that is still difficult but in which most players would benefit.?

The study suggests that even if Greece achieves a nominal growth rate of more than 4 percent of gross domestic product this decade and the interest rate spread of its government bonds against German Bunds fall to 350 basis points, would not be able to maintain the necessary budget surplus and could not therefore service its debt.

?The primary surplus required to reduce the debt ratio to 60 percent of GDP [as eurozone rules demand] in 20 years would be 8.4 percent of GDP,? the Bruegel paper says. ?It would reach 14.5 percent of GDP under the cautious scenario. This would imply devoting between one-fifth and one-third of tax revenues to interest payments on public debt.?

?In political and social terms, it?s very unlikely this would be sustainable,? said Darvas, adding that no OECD country, apart from oil-rich Norway, has sustained during the last 50 years a primary surplus above 6 percent of GDP.

New Democracy leader Antonis Samaras has suggested making better use of the state?s property holdings as a way of boosting the Greek economy, but Bruegel, which is held in high esteem by European policy makers, says that even a major divestiture of public land ?would be insufficient to modify the conclusion.?

?Our conclusion therefore, is that Greece has become insolvent and that further lending without a significant enough debt reduction is not a viable strategy,? the think tank argues.

Greece is in negotiations to have the interest rate on the 110 billion euros it is borrowing from the EU and the International Monetary Fund reduced and the period it has to repay the money extended. But Darvas and his fellow economists argue that these measures ?would be insufficient to return the country to solvency, since they would still leave it with an unrealistically high primary budget surplus requirement.?

Instead, they insist that the only way that Greece will be able to reduce its debt to a manageable level over the next 20 years is for investors to accept a 30 percent reduction on their returns from investing in Greek debt. Bruegel proposes that a decision for Greece to restructure its debt should be taken at the next EU leaders summit on March 24-25.

Germany and France have insisted that as part of a European Financial Stabilization Mechanism (EFSM), private investors should pick up part of the bill for any eurozone country being bailed out in the future by accepting a haircut on that government?s bonds. Darvas argued that this has created an inconsistency, which only puts more pressure on Greece to default.

?The current situation is clearly inconsistent because what you are saying is that from 2013, the new bonds will have a collective action clause which will make it easier to default on the new debt but at the same time you are saying there can be no default on the current debt,? he said.

?If Greece has government debt of 160 percent of GDP and somehow muddles through to 2013 insisting that there will be no restructuring of the existing debt, then who will buy the new Greek debt, which will have an easier option for defaulting? Nobody. Greece will not be able to go the market and will need a new [bailout] program or will have to default on the old part of the debt,? said Darvas.

The possibility of Greece receiving a second emergency loan package, when the current one expires in 2013, is a scenario that Darvas finds unlikely, because by that time the EU and the IMF will already hold roughly a third of Greece?s debt and will probably want to avoid greater exposure.

He also dismissed the view Greece?s debt should be manageable since the cost of servicing as a percentage of GDP has actually decreased since the 1990s. ?What you should look at is the real interest rates,? he said. ?At that time you had a 15 percent interest rate and 17 percent inflation, or something like that, but now what you have is very low inflation and very high interest rates, so the real interest rate is much higher than it was at that time.?

Darvas was adamant, however, that any restructuring should be accompanied by ?credibility enhancing measures? from the EU. The report suggests a ?temporary refocusing of structural funds? to support growth strategies.

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