PSI: Gift horse or Trojan horse?

Given that Greece struggled for weeks to find just a few billion euros in savings to convince its eurozone partners to grant a second bailout, you?d have thought the wiping out of some 100 billion euros from the country?s debt pile ? the largest restructuring the world has seen ? would have been greeted with the world?s largest collective sigh of relief. It wasn?t.

The lack of high-fiving and back-slapping on the streets of Athens does not mean the bond swap should be dismissed. After all, it?s perhaps the first time in this crisis that all parties involved accepted that Greece can?t pay its debts and that they needed to do something practical about it.

Perhaps the private sector involvement has come late in the day but its arrival could signal a more pragmatic approach to the crisis.

One thing it certainly underlines is that Greece should have no fear of negotiating its position in the future. Making this deal happen was not a given and some credit has to go to the Greek officials that managed to wade their way through the shifting sands of international finance to get it done. It also shows the value of picking good advisers and heeding their advice. Greece turned to New York lawyer Lee Buchheit of Cleary Gottlieb, who had unrivaled experience of handling sovereign debt restructuring, and stuck with him. The last few months have compared favorably with the premiership of George Papandreou, when advisers paraded through his office but no common line was adopted.

Greece also overcame the mulishness of its eurozone partners, who took a back seat in the protracted talks Greek officials held with banks, insurance companies and investors over the haircut. In fact, the conflicting messages emanating from European capitals often hindered the negotiations. Neverthless, a deal was reached and a target was met: How many times has Greece been able to say that over the last couple of years?

But that?s not the whole story. PSI gives Greece relief on debt and interest repayments (Athens will save some 15 billion euros a year), as Prime Minister Lucas Papademos rightly pointed out on Friday, but this financial breather comes with some tough conditions. As churlish as it may seem to look a 100-billion-euro gift horse in the mouth, we should not forget that the Trojan horse was also a gift.

One of the key weaknesses of the debt restructuring is that it looks appealing but when you delve inside, there are some rather nasty surprises, much like the residents of Troy discovered a few thousand years ago.

While Greece may be reducing its debt by 100 billion euros, it is also borrowing heavily to do this. So much so, in fact, that its debt to GDP ratio is still projected to be more than 150 percent of GDP this year and almost unchanged in 2013.

Of the 130-billion-euro bailout that Athens is to receive from its eurozone partners and the International Monetary Fund, 30 billion euros will be used to buy bonds to be given to investors who took part in the swap, 5.5 billion euros will be used to pay off interest on outstanding Greek bonds and about 50 billion euros will be used to recapitalize Greek banks, which submitted their bond holdings for a haircut. Only about 35 billion euros, or just under 20 percent, of the bailout money will go towards the broader Greek economy. As with the first loan package, the majority of the money borrowed from the EU and IMF will end up outside the country.

As Landon Thomas pointed out in the New York Times on Friday, Greece is essentially transferring its debt pile from the private sector to the official sector. When the crisis began, virtually all of Greece?s sovereign debt was in private hands but now it only holds about a quarter. The significance of this is that if Greece needs to restructure its debt in years to come, it would need the acquiescence of the European Central Bank, its eurozone partners and the IMF. Trying to get all these parties to agree would make the PSI talks look like a straightforward friendly gathering.

A sidebar to this is that as a result of the bond swap, which provides investors with Greek bonds issued under UK law, a further restructuring of this debt is not a viable option.

Furthermore, the restructuring will damage pension funds, which held about 7 billion euros in Greek bonds, companies that supplied the state and were paid in bonds rather than cash, and thousands of investors who thought that sovereign notes were a safe place to put their money.

So, while Greece saves 100 billion euros, it will borrow almost the same amount to plug the holes created by the haircut. Then there is the collateral cost of failing pension funds, businesses whose cash flow has been blown out of the water and savers who have had their hands bitten.

To counterbalance the blow to pension funds, Greece will likely have to overhaul its pension system for a second time in two years. A seemingly unavoidable reduction in pensions will further damage vanishing aggregate demand.

This highlights the biggest problem underlying the debt restructuring, which is that it?s unlikely to have any immediate or positive impact on the state of the Greek economy. With perfect timing, unemployment and GDP figures were released by Greece?s statistics office either side of the PSI deal being clinched.

The jobless rate reached 21 percent at the end of last year, and rose to more than 50 percent for young Greeks. Greece?s economy shrank by 6.9 percent of GDP in 2011, underlining what a perilous situation it?s in. With the economy shrinking at such a rate, Greece?s debt would grow proportionally even if the government didn?t spend another euro. More importantly, the continuing recession will create a funding gap as revenues will not be able to keep up with spending, despite widespread cuts.

The economy is forecast to contract by more than 4 percent this year, so Greece is due to encounter this problem very soon. JP Morgan?s economic research team suggested in a note on Friday that the shortfall would be 20 billion euros between 2012 and 2014. There is serious doubt over whether Greece?s lenders would be willing to provide the money to bridge this gap.

?Barring additional support, Greece could increase issuance of T-bills, reduce the cash buffer, default on maturing bonds held by the European Central Bank or amortizing IMF loans, not pay arrears or avoid recapitalizing social security fund, or close the primary deficit more abruptly,? say JP Morgan?s researchers.

All these options carry great risk: Some would antagonize Greece?s lenders, some would anger the Greek public and others would, ironically, add to Greece?s debt.

If PSI is to be a gift horse, then Greece will have to find a way to shut the gate before it bolts.

[Kathimerini English Edition]

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