Three steps to avoid restructuring

The determination of the Greek government, the EU and the IMF to avoid the restructuring of the country’s public debt should not be doubted. This does not mean, however, they will be successful. Greece may proceed with a partial restructuring of its debt held by official lenders but this may not be the kind of credit event many market participants have in mind. However, it still has a chance to avoid even this by taking some other steps. By all accounts, the Greek economy is heading deeper into the worst recession in the last few decades. The gross domestic product (GDP) fell 1.8 percent in the second quarter compared to the first, confirming widespread evidence from the business community that main sectors of the economy, such as construction, real estate, retail and wholesale commerce, are under severe strain. This is largely the outcome of an overdose of austerity administered by the government and the so-called troika, that is, the EU, the IMF and the ECB, to achieve an ambitious reduction of the general government budget deficit to 8.1 percent of GDP from an estimated 13.6 percent in 2009. It is another reminder that orthodox economic textbook models, even modified, cannot be applied to all countries under all circumstances. With tax revenue growth slipping as austerity bites and higher taxes hurt consumption, it becomes clear that the attainment of the budget deficit target may be tougher than initially thought. This is so because the economy is hurt in a profound way, as the productive private sector is called upon to share a larger burden of the fiscal adjustment than it should – although the blame for the mess of Greek public finances rests squarely with the unproductive public sector. More and more businessmen, bankers and employees in the private sector who are feeling the heat are obviously disappointed and angry. The following quote by a middle-management employee in one of Greece’s largest construction groups captures the frustration: «Do you know why this is all happening? For the civil servants, who are not threatened by unemployment, and our creditors to be paid in time.» Whatever the case, it is clear that the number of Greek corporate officials who believe in the so-called «good scenario,» that is, that the country will put its public finances in order, contain the economic downturn and be able to borrow at relatively reasonable interest rates next year, is diminishing. According to them, the best possible outcome would be for the official lenders to agree to a roll-over of the 100 billion euros provided to Greece over a longer period to smooth out the payments related to the service of the public debt. This is not a credit event and therefore will not trigger clauses in Greek credit default swaps (CDS) or others linked to holdings of Greek bonds by private investors. Most pessimists on the Greek economy do not rule out this happening in the next few months, while others place it in mid-2011. Even the most optimistic think it is likely we will see a restructuring of this portion of Greek public debt. They think it is likely to take place at the end of 2011 or beginning of 2012. Their idea is primary spending, which does not include interest expenditure on public debt, should be equal to revenues so the country can stand on its feet and have greater leverage over its creditors when this happens. However, it is unclear that it will be possible to attain this in late 2011 or early 2012. It may be reasonable to think this way but it is uncertain whether some EU countries or even the IMF will go along with it, although this is likely given the alternative if Greece cannot still borrow in the markets. What can be done to avoid even the official restructuring of Greek debt and make it possible for Greece to borrow at reasonable terms in international markets in late 2011 or early 2012, assuming a benign world financial environment? Three steps should be taken. First, fiscal consolidation should continue but more attention should be paid to the real economy instead of just taking measures to meet the budget deficit reduction target. This means Greece has to mobilize foreign direct and indirect investments. Second, an upgrade of its credit rating status by Moody’s or S&P at some point in the first half or nine months of 2011 should be pursued with the help of the EU and the IMF. This will help bring down Greek spreads and create a better environment for the country’s bonds. Third, Greece should try to convince sovereign wealth funds to buy a considerable chunk of its new bonds when they are issued. It is positive that Norway’s sovereign wealth fund stated it is a buyer in Greek bonds because it does not believe the country will default on its debt but this is not enough. Greece had flirted with selling its bonds to the Chinese in the past and should go back to them. The same holds true with Arab or other sovereign wealth funds in the Far East. We stress sovereign funds because they usually are not held back by their statutes for not buying government bonds if a country is not rated investment-grade by at least two major credit rating agencies, as is the case with most other investment funds. All-in-all, market participants may be right in reckoning the restructuring of the portion of Greek debt held by the country’s official creditors is likely. Even so, Greece should try to make it easier for itself and everybody else by taking the three steps outlined above. This way, it may succeed in doing what most market participants think today is unimaginable.