Bruegel economist sees only two options for Greece

The second bailout package for Greece may buy the country some time but Zsolt Darvas of the Brussels-based Bruegel think-tank is skeptical about whether it will be approved and whether the agreement will include demands for collateral.

In an interview with Kathimerini, the Hungarian economist stated that private sector involvement is ?at best inadequate, as it cannot change the dynamic of the Greek debt.? Darvas noted with concern the recent market attack against Italy, whose economy is too large to be covered by the European support mechanism.

?If Italy received a traumatic attack in September, this would pose a structural question,? according to Darvas, who suggested that one solution would be for Rome to seek assistance outside the eurozone or from the International Monetary Fund (IMF). Another, he added, would be for the European Central Bank (ECB) to purchase bonds from the primary market, which amounts to printing money.

Issuing a Eurobond, however, is what Darvas sees as the ?natural? development. In fact, Bruegel has put forward a proposal for a so-called ?Blue Bond,? which, Darvas explained, ?could cover the debt to a certain percentage of GDP, which would be jointly guaranteed by all the members of the eurozone and would have a low rate of interest. For debt above 60 percent of GDP, let?s say, countries would have to provide their own guarantees and the interest rates would be much higher, so there would be a strong motivation from the markets for fiscal discipline.?

This, argued Darvas, ?would break the bond between state debt and bank debt, because right now, for example, if Greece defaults its banks will follow suit, whereas if a separation existed, even a default would not create problems for Greek banks as there would be joint guarantees covering that percentage.?

The economist believes that Greece has two options at this point.

The first is for eurozone leaders to agree to lend money over a long period of time, one or two decades, at a low rate of interest. ?In effect,? Darvas said, ?there should be no extra burden beyond the Euribor rate.?

The second is a restructuring of the debt, for example ?a debt swap so that Greece?s current debt can be swapped with a bond that has a very high credit rating, which could be issued by the EFSF or some similar European mechanism. If it is issued by Greece, it would need EFSF guarantees. The swap should take place at 50 percent of the bond?s nominal value so that the value of privately owned bonds is reduced by half.?

Darvas believes that Greece needs to repay the entirety of its official debt, as the basic principle of the assistance mechanism is that lenders have priority ahead of other creditors, apart from the IMF, which has primary status. He warned that ?if you [Greeks] wait too long, this option will no longer be on the table as an increasing amount of debt is passed onto your eurozone partners.

?I believe that you can wait another year, however, and it is best if you do, because the Europeans are not prepared for such a drastic measure. This is why Greece needs to make itself ready and to put the necessary mechanisms into operation. Meanwhile, eurozone banks also need more time to become stronger in order to contain contagion,? the economist added.

Independently of the debt crisis, however, Darvas believes that Greece has no other choice but to proceed with fiscal adjustment, structural reforms and the proper management of state-owned companies.

?I appreciate the efforts being made by the government at a particularly difficult time and this must continue. This will show the citizens that the government supports the program and will also reduce the uncertainty of depositors and investors. Because right now, there are those who are going as far as saying that Greece needs to leave the eurozone. Personally, I disagree, but when people see so many mixed signals they have no idea what will happen and this uncertainty deepens the crisis.?