Debt restructuring: more pain than gain for Greece should it heed recommendations

The medicine of Greek debt restructuring suggested by some may be worse than the fiscal illness of the country it is supposed to cure. In this respect, Greece has no choice but rise to the occasion, confront the solvency challenge and overcome it. There is no doubt that the country faces a difficult task in reducing the budget deficit by 11 percentage points of gross domestic product to below 3 percent of GDP in 2014 – even more so due to the erosion of the international competitiveness of its economy and adverse demographics. However, analysts are already pointing to a weaker euro as a welcome sign, since some two-thirds of Greek exports go to non-eurozone countries. A weaker currency helps to restore some of the lost price competitiveness. Some of these analysts also point to the enormous 2009 budget deficit, saying it would have been smaller than it appears, had one-off factors and other technicalities had been taken into account. They are essentially implying that it will be easier than meets the eye for Greece to make the real fiscal adjustment over the next few years. However, many international analysts and commentators continue to argue that Greece will have to restructure its public debt at some point in the future. A few have even argued that debt restructuring, which is viewed as a type of technical default, could have happened as early as May – and turned out to be flatly wrong. Of course, this would have been impossible with the multiyear package worth 110 billion euros, made up of 80 billion in bilateral eurozone loans and 30 billion in International Monetary Fund loans, and a 20-billion-euro disbursement in May. The EU/IMF financial support package eliminated the default risk arising from the lack of sufficient funds by the government to pay back its maturing debt and finance state expenditures in the short run. On the other hand, whether or not the program was put into place to fence off Greece and stop contagion to Portugal, Spain, Ireland and Italy remains to be seen. It would be silly though to assume Greece will be left out in the cold by its eurozone partners and the IMF if it honors its obligations under the multiyear program. Assuming the country sticks by the conditions imposed in the program, it is estimated it has gained breathing room of almost two years to return to the markets. Finance Minister Giorgos Papaconstantinou suggested at some point Greece would like to return to the markets in 2011 or the first quarter of 2012 at the latest. Of course, there is much uncertainty over the outcome, as the Greek economy is heading into a deeper recession. Still, the chances are the country will meet the 2010 budget deficit target of 8.1 percent of GDP, from an estimated 13.6 percent in 2009, on the back of frontloaded strict fiscal measures – assuming the state apparatus functions normally. It is understandable that even this may not be enough to convince analysts and others who see the projected debt-to-GDP ratio topping 149 percent of GDP in 2013. They are the ones who assume that debt restructuring is inevitable. Solvency question However, there remains one serious question. How does one measure solvency? One may argue it is reasonable to define solvency as reducing the public debt ratio to 60 or 70 percent in 2030 or 2040 or 2050. Another may define solvency as stabilizing the public debt-to-GDP ratio and then setting it on a permanent downward path by a consistent fiscal adjustment, producing large primary budget surpluses, as Belgium did in the past. Of course, the difference between the two definitions may be vast as far as the necessary fiscal adjustment is concerned. Assuming the more lenient definition of solvency implied in the multiyear EU/IMF program for Greece, one can easily see that a debt restructuring would not help much. Greece could have entered into a voluntary agreement with its creditors to reschedule its maturing debt over the next three years by exchanging old bonds for new ones of longer maturity and the same coupon and face value. This would have improved its liquidity profile in the next few years, because it would have had to pay less in bond redemptions but would not have helped its solvency case. Even if creditors would have accepted the exchange of old bonds for new ones of longer maturity and lower coupon and capital values, the so-called «haircut,» the reduction in coupons and/or capital would have been large so as to cut the country’s public debt-to-GDP ratio to around 60-70 percent. Even so, halving the public debt-to-GDP ratio will reduce the interest bill of the budget but will still require a considerable fiscal adjustment in the years to come. According to realistic scenarios, this may reduce the necessary fiscal adjustment by less than four percentage points compared to the 11 percent projected in the EU/IMF program. Given the fact that a debt restructuring would make it almost impossible for Greece to borrow on international markets for years without some kind of EU support and its banking sector would weaken significantly, this should not be a choice for Greece and its policymakers, because the overall pain would be greater than the gain.