Convergence on debt sustainability

Greece is likely to enter a pre-election period after Monday’s third presidential vote in Parliament, with the leftist SYRIZA party leading in opinion polls, followed by conservative New Democracy. The sustainability of the public debt is expected to be at the center of a polarized pre-election campaign along with other issues. It is interesting and characteristic of Greek politics that the two major political parties seem to agree that the debt is unsustainable but prefer instead to disagree on the matter in public.

The gross debt of the general government is estimated at 175.5 percent of gross domestic product this year from a bit lower in 2013. It is projected to drop to 168.8 percent in 2015 and 157.8 percent in 2016 according to European Union estimates. This is one of the highest debt ratios among developed countries and is much higher than Greece’s 103 percent ratio back in 2008 and 127 percent in 2009.

Many analysts and others attribute the sharp deterioration to excessive austerity, arguing it deepened the recession and made it last longer. Greece is estimated to have lost about a quarter of its output between 2010 and 2013, with the unemployment rate skyrocketing to about 27 percent of the work force.

Of course, others attribute the sharp rise of the debt ratio and the severe drop in economic activity to the country’s inability or unwillingness to implement a series of structural reforms. We have long held the view that excessive austerity has contributed more than delays in reforms to the economic downturn and the subsequent rise in the debt-to-GDP ratio, the so-called debt trap.

Last time eurozone finance ministers discussed the debt sustainability issue was back in November 2012. At the time, the Eurogroup committed to taking debt relief measures on the condition Greece produced a primary budget surplus and showed progress on reforms. It also approved the buyback of Greek bonds in private hands by the country to reduce the nominal debt.

The transaction, which seemed to be the result of a deal between the EU and the International Monetary Fund at the time, cut the debt by about 20 billion euros or about 10 percentage points of GDP. The bond buyback was funded by a European Financial Stability Facility (EFSF) loan totaling 11 billion euros or so. This amount was taken out of the EFSF loans destined to fund the Greek adjustment program, opening a hole of equal magnitude.

Greek government officials claim there was an informal agreement with EU officials at the time that the bloc would find a way to replace those funds. This never happened and Greece found itself with a funding gap of similar magnitude for 2015-16 as the end of the program neared. The government officials claim one idea was to have the European Central Bank agree to roll over its Greek bonds which were not subject to a haircut when the debt restructuring, PSI Plus, took place in early 2012. Assuming the Greek officials are right, the country should not have faced a funding gap or at least come up against a small one. Perhaps, SYRIZA leader Alexis Tsipras had this in mind when he mentioned the rollover of Greek bonds held by the ECB. Both parties could also agree to bring back the issue of debt relief measures to which the Eurogroup committed back in November 2012.

Of course, SYRIZA has taken a hard line by seeking a haircut on the nominal value of the EU loans compared to the more realistic approach of a debt maturity extension and the conversion of floating interest rates into fixed favored by New Democracy and others. It is generally accepted that a haircut is highly unlikely for various political and other reasons. However, Tsipras often evokes the 1953 London Debt Agreement, which resulted in a 50 percent haircut on outstanding German external debts, easing the way for the country to become an economic power. It is a sensitive issue Germany would not like to open but SYRIZA may want to it bring up, perhaps seeking something else.

Talking to some market people close to SYRIZA’s moderate wing, one gets the idea this could be the reduction of the Greek debt by having the European Stability Mechanism (ESM) assume the bank recapitalization costs. Greece borrowed more than 25 billion euros from the EFSF to recapitalize its four core banks and more than 10 billion to cover restructuring costs. In total, it has borrowed about 39 billion euros to that end. By having the ESM assume these loans, the Greek debt could be reduced by a similar amount, an indirect haircut.

This idea is also favored by New Democracy party officials as far as we know, so there is common ground with SYRIZA. However, such a move will have to have the blessing of the EU and this is not likely without any Greek government’s commitment to reforms and a number of SYRIZA officials have vehemently opposed austerity and reforms.

The two major parties also find themselves of the same mind on the issue of the sustainability of the public debt.

SYRIZA officials have said the country cannot afford to produce the large primary surpluses to the tune of 4-4.5 percent of GDP for several years as cited in the program. It is another way of saying the Greek debt is not sustainable. On the other hand, government officials, including Premier Antonis Samaras, have said the debt is sustainable. However, high-level Finance Ministry officials and others have told troika representatives that the target for the primary surplus should be lowered because it is too high. In other words, both political parties basically agree on this issue although they prefer to disagree in public.