Paris Club could help provide Greece with long-term solution to debt problem

Eurozone governments may disagree but most pundits think Greece?s public debt is unsustainable and will have to be restructured at some point. If the pundits are right, the country will most likely be called upon to do so after mid-2013, when the proposed European Stability Mechanism (ESM) succeeds the current European Financial Stability Fund (EFSF).

This may suit everybody, especially the other eurozone countries and their banks, since the so-called contagion effect is likely to be smaller by then. Although this is desirable, it may not be feasible if Greece is unable to implement the economic program. Therefore, another solution, perhaps a Paris Club one, may be more suitable and better for Greece and everybody else and should be implemented earlier.

There is no doubt that the reduction of the interest charged on the official loan to Greece from eurozone countries may help alleviate somewhat the country?s debt sustainability program but it certainly does not resolve it.

Although lowering the interest burden of servicing the debt is important, it is likely to be offset, at least partially, by a more sluggish economy facing a huge debt-to-GDP ratio close to 160 percent in the next few years.

The Hellenic Statistical Authority confirmed that real gross domestic product fell 4.5 percent last year compared to earlier expectations of 4.0 percent, contributing to an even bigger budget deficit, likely in the order of 9.6-9.8 percent of GDP. Moreover, it looks likely that the economy may drop by more than the estimated 3.0 percent this year.

It is reminded that nominal GDP growth, the average cost of debt and the primary budget surplus are the three key parameters in any debt sustainability exercise. For Greece, which starts from a high debt-to-GDP ratio, a large primary budget surplus along with economic growth exceeding the average cost of debt is the preferred combination to put the debt-to-GDP ratio on a downward path fast.

However, more and more analysts believe this can be achieved without some kind of debt relief.

Although many in Greece did not pay much attention to it, the recent statement by the European Council (EC) shed some light on this issue post mid-2013.

The EC?s statement denotes that a country deemed to be insolvent on the basis of the debt sustainability analysis conducted by the Commission and the IMF in liaison with the ECB has to negotiate a comprehensive restructuring plan with its private sector creditors to restore debt sustainability.

If the restructuring plan can achieve debt sustainability, the ESM may provide fresh loans, it said.

These loans will enjoy a ?preferred creditor status,? junior only to IMF loans, meaning private sector holders of government bonds issued by member states borrowing from the ESM will have their claims subordinated to those of official creditors.

According to credit rating agency Standard

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