Rare growth-linked debt could work for Greece

Greece’s proposal to swap debt held by its euro zone creditors for bonds with payments linked to economic growth got a cool reception in European capitals this week, with one official calling it a «new trick» to a haircut.

It would be the first time official creditors signed up to an idea that is unpopular with private bondholders and only has a couple of private sector precedents. While some see the bonds as a reform incentive, others see a way to dodge paying up.

But a growing number of economists say that it could be the right method to give Greece’s new leftist government the breathing space on its hefty debt payments that it says it needs to get the economy back on track after its financial crisis.

They say the official sector, which holds the purse strings of Greece’s international aid package, would have more leverage than the private sector in recouping its dues – the top concern about such bonds.

“The official sector would have more power than a private investor if it felt that a country was cooking the books,» said Marcus Miller, a professor of economics at Britain’s Warwick University.

“It may also have some ways of getting the money as well because the European Union can levy taxes on countries.”

Miller and nobel prize-winner Joseph Stiglitz were among 18 eminent economists who recently wrote in a letter to the Financial Times that growth-linked debt relief should be part of a plan to help Greece recover.

The governments proposals are vague although comments made by new finance minister Yanis Varoufakis to investors in London on Monday suggest they are targeting loans from other member states and the bloc’s bailout fund EFSF. Greece’s debt to the euro zone totals 196 billion euros.

There are few recent cases in the private sector. Argentina and Greece itself issued growth-linked warrants to reluctant bondholders as an extra sweetener after a restructuring.

“All of the problems that we have identified with these growth-linked bonds in the private sector do not relate to the official sector,» said Starla Griffin of Slaney Advisors, who in 2013 published a survey on investor attitudes towards growth-linked bonds.

Griffin, a member of the UN’s committee on sovereign debt restructuring, identified three main areas of investor concern: difficulties of verifying growth data, trading and regulatory complications, and uncertainty of income.


Probably the biggest hurdle is one of trust. Argentina, for example, spent years dodging payouts on their inflation-linked debt after reporting consumer prices that differed wildly from private estimates.

But official creditors check economic data as part of the conditions of the international bailout, so they could keep tabs on it themselves.

“They have more information than anybody,» said Griffin.

“If it was structured properly, you would have some sort of certifier of the data.”

A second concern for investors is how to measure such an asset’s worth because it fluctuates in value during economic booms and busts. The value is needed for trading but an official creditor would hold the bond until it expires.

Private investors also have to constantly report the value of their portfolios to regulators but Greece’s euro zone partners, are not subject to the same regulatory oversight.

The final problem raised in Griffin’s survey was that fund managers may struggle to match the returns on these bonds to their clients’ demands. Most bonds pay a fixed-rate of interest.

RBS strategist Michael Michaelides believes any loss taken on interest payments may be something politicians would accept if they could tell European taxpayers they were getting back the initial sum loaned.

“A GDP linkage of the debt may be useful politically for all sides, hence defusing what could become a tense game of ‘chicken’,» he said.

Nevertheless, if any loss of interest was seen as a writedown by the back door it could be a breach of European Union law, producing a hurdle that could be hard to clear.

The Greeks – many of whom blame Germany for the strict austerity that they say crippled their economy and left a quarter of them out of work – may have another card to play.

In a bid to revive the German economy after World War Two, creditors tied repayments to its trade surplus. The UK also had similar relief on a U.S. loan.