To some it seems inevitable that Greece?s debt has to be restructured. To others — among them the political elite of Europe — the problem simply boils down to finding ways to refund the debt. The hypothesis is that eventually Greece will be able to pay its debt by restoring balance to public financing through reducing public expenses and increasing revenues by raising taxes and selling assets, ultimately reducing public services. I belong to the group of people that believe that restructuring is the only way out — part of the Greek debt has to be forgiven by creditors.
It is fairly obvious that restructuring the debt runs the risk of triggering contagion in Europe. Not only will the balance sheet of creditors be severely hit but it might also create moral hazard problems. How will other sovereigns in the region with serious debt problems react to creditors forgiving debt of one country but not another? Will they demand the same understanding of creditors, creating even greater problems for Europe?
Rolling over the debt and adding more to it will likely buy Greece valuable time. However, in the longer run it will suppress economic activity in the country as taxes have to be raised and severe fiscal austerity has to be introduced to service the growing debt burden. Also assets have to be sold — probably in a fire sale. Even with these measures there is no guarantee that Greece will eventually be able to withstand the heavy debt burden imposed by the suggested proposals. Moreover, it is highly unlikely that economic growth will pick up in the foreseeable future, making this an even more dangerous road to travel.
Another problem with the debt rollover idea is that the balance sheet of creditors will unavoidably deteriorate. Greek debt will have to be valued substantially less than nominal value as the risk of a major credit event will still be high (assuming a mark-to-market loss). This will require creditors (that hold Greek debt at nominal value on their books) to recapitalize exactly as they would have to do if the debt was restructured.
I think that the only rational solution is to restructure the Greek debt. Rolling over current debt and adding to it prolongs the uncertainty in Europe. It will probably require as much recapitalization of creditors as restructuring, and it might drive Europe into a situation similar to that of Japan in the 1990s. With restructuring it is likely that growth will take off in Greece and uncertainty will be reduced in the eurozone. Fears about the country leaving the euro will most likely calm. Only one thing is certain: Rolling over the debt and adding to it will decrease the economic well-being of the average Greek for years to come.
* Dr Tryggvi Thor Herbertsson is an MP and a professor of economics. He was the special economic adviser of Iceland?s prime minister during the collapse of the Icelandic banks.