How Greece can get around a debt restructuring with the help of creditors

Greece and the international representatives of the International Monetary Fund, the European Commission and the European Central Bank, known collectively as the troika, insist the country is on track to meet its budget deficit goal for this year and benefit from the adoption of bold structural reforms in the medium-term. However, the markets are yet to be convinced this is the case judging from the kind of elevated spreads demanded for Greek bonds and credit default swaps (CDS) and public positions of some market gurus like Pimco’s Bill Gross or Templeton’s Mark Mobius. Although it is not easy to get the pessimists to change their minds, it may not be impossible with the right mix of economic policies, financial engineering and, above all, political will. Poul Thomsen, the top representative of the IMF in Greece, acknowledged the grim market reality when his turn came during last week’s presentation of the Greek economy to foreign investors and analysts in London. Thomsen reportedly told the audience he knew beforehand he could not make them change their mind that Greece would default but he went on to make his case. Undoubtedly, it is unprecedented to have EU, ECB and IMF officials accompany the finance minister of a debt-ridden country on a road show to convince foreign funds, banks and others that the country will not go belly down. On the one hand, this shows the international community’s commitment to the survival of the Greek economy and, on the other, how high the stakes are here, particularly for the eurozone and the IMF’s reputation in this case. Greece should take advantage of this show of support by the international community and address head-on the main concerns of foreign investors, that is, a protracted economic recession and a higher public debt-to-GDP ratio in the next few years. One should remember the Greek economy is projected to shrink by 4 percent this year and 2.6 percent in 2011 after contracting 2.0 percent in 2009, according to EU estimates included in the first review report on the country’s economic program. The general government budget deficit is seen dropping to 7.8 percent of GDP this year from an estimated 13.6 percent in 2009 and falling further to 7.6 percent in 2011, 6.5 percent in 2012, 4.9 percent in 2013 and 2.6 percent in 2014. But the general government gross debt is seen rising to 130.2 percent of GDP in 2010 from 115.1 percent in 2009. It is forecast to rise further to 139.8 percent in 2011, 144.4 percent in 2012 and 145.3 percent of GDP in 2013 before starting to ease. Although a few major banks, such as Goldman Sachs and HSBC, see value in long-term Greek government bonds, their recommendations are based more on relative value and the idea that the bonds are very cheap, encompassing a generous haircut than anything else. It is a first good sign but not good enough to make many investors change their minds. At this point, it looks as if the Greek side and the troika may have to expect that Greece’s sticking to fiscal consolidation targets and the reform program will be better received by the the international credit rating agencies than the markets in the next couple of quarters. Having Fitch or Moody’s change their outlook on Greek debt to stable from negative in the months ahead will be another good sign which may help compress Greek spreads to July levels or even below. However, they will not bring about the hoped-for breakthrough either. Greece will have to demonstrate it is able to attract large-scale foreign direct investments (FDI) and break its isolation from the world capital markets by having sizable inflows in portfolio investments. These could help improve sentiment before an expected upturn in tourist receipts by next summer. If the economy starts showing signs of bottoming out and recovering, Greece will have addressed one of the major concerns of foreign investors. However, to address the second major concern, that is, the rising public debt-to-GDP ratio, will be more difficult. Undoubtedly, asset sales can help but cannot drive the debt-to-GDP ratio to 100 percent or below in the next three years as some market participants think it is necessary to convince global funds to flock back to Greek bonds. It is a far-fetched proposition but some think some financial engineering could help to reduce the debt ratio, starting with the Greek bonds held by the ECB. According to this idea, the ECB is thought to hold some 40 billion euros of Greek bonds with a nominal value of 60 billion and could well increase its holdings further. The ECB could sell these bonds to the European Financial Stability Facility (EFSF) at the current price and the latter could issue EU-backed bonds at 60 basis points over Euribor to finance the purchase. Next, EFSF could sell these bonds back to Greece after providing the latter with a loan of equal size priced at Euribor plus 250 or 300 basis points. EFSF makes money on the loan to Greece because it earns some 190 to 240 basis points more, the ECB sells the paper and Greece buys back its debt cheaper. Undoubtedly this proposition and similar ones are not a panacea. However, they may prove more potent than they appear at first if they indeed help ease market concerns about Greece’s sky-high debt ratio in the years ahead. There is no question that it is better for Greece to combine prudent fiscal policy and growth initiatives with a reduction in the debt ratio rather than hope to access the international markets next year or in 2012, having only to show progress on the fiscal front.