Europe’s leaders have reached Plan C in their efforts to rescue Greece. Unfortunately, it lacks a crucial element also absent in Plans A and B: adequate debt relief.
The agreement between euro-area finance ministers and the International Monetary Fund is welcome and overdue. It provides much-needed support for a Greek government that has taken enormous political risks to meet the conditions for aid. It also puts an end to weeks of bickering between Europe and the IMF over how to cover Greece’s funding shortfall — a delay that had threatened to undermine faith in the bailout program, even among Greeks who believe in making the changes and sacrifices demanded.
The deal, however, doesn’t do enough to address the biggest issue: a Greek government debt burden that, at about 170 percent of gross domestic product, remains unbearable under any reasonable scenario. The agreement assumes that Greece will largely grow its way out of the problem, reducing its debt to less than 110 percent of GDP by 2022 even as it endures the crushing austerity required to sustain a budget surplus of 4 percent of GDP. In other words, this is just the latest in a long line of stopgap measures to fend off the kind of disorderly default and euro exit that could trigger contagion in the much larger economies of Spain and Italy.
Germany and other creditor nations refused to consider the simpler and more effective solution of writing off some of Greece’s debt to official lenders, a move that would amount to an explicit fiscal transfer. Instead, they agreed to reduce Greece’s debt-service costs, extend its repayment period and lend it money to buy back bonds held by private investors. Taken together, these measures are supposed to amount to debt relief equivalent to about 20 percent of GDP by 2020. The IMF, for its part, relaxed its previous requirement that Greece get its debt down to 120 percent of GDP by 2020.
The contortions might be necessary to help the deal get through the various national parliaments that must ratify it, but they could extract a higher price down the road. Some euro- area countries, for example, will now be paying more to borrow money than they receive in interest from Greece. That’s a fiscal transfer by sleight of hand, as is the 10-year extension of some debt maturities and a repayment holiday on loans that the European Union and the IMF pledged earlier this year. Perversely, much of the burden will fall on countries that are also in economic trouble. Italy and Spain, for example, will have to pay Greece for the privilege of lending to it, because their financing costs are higher than the reduced interest rate at which Greece will borrow.
The debt buyback from private investors, too, promises to be problematic. The idea is that the low market price of Greece’s debt creates an opportunity to retire it on the cheap, by borrowing new money to buy old bonds. If, for example, Greece can buy back its bonds at 33 cents per euro of face value, it can get rid of about three euros in debt for each new euro it borrows. Problem is, the price of the bonds tends to rise as markets come to expect the buyback, eroding the benefits to Greece. The country’s 10-year bonds currently trade at almost 36 cents on the euro, up from about 31 cents in early October.
In a ham-handed attempt to ensure the buyback’s benefits, the bailout agreement stipulates that Greece can’t pay more than the closing price of its bonds on Nov. 23. As a result, the government might not be able to find investors willing to sell their bonds at its offer price — an outcome that could jeopardize the release of the IMF’s 43.7 billion euro share of the bailout money, which is contingent on the completion of the debt buyback. The euro’s initial bounce from the deal announcement has faded as this reality has sunk in among investors.
Perhaps the biggest difference between Plan C and its predecessors is that responsibility for failure has shifted. Previously, Greece shouldered the blame for its inability to come to grips with the task at hand. Now, the creditors’ plan itself is more likely to be the sole culprit. German Finance Minister Wolfgang Schaeuble seemed to acknowledge its flaws in a news conference Nov. 27, saying that if the buyback fails, the troika — the IMF, the European Commission and the European Central Bank — will have to take “other measures.”
When the time comes to craft Plan D, Europe’s leaders would do well to move ahead with the Greek debt writedown they have tried so hard to avoid. If, for example, they cut the government’s debt in half, and if its market borrowing cost could be brought down to about 5 percent, Greece could hold its debt burden steady by running a primary budget surplus (excluding interest payments) of roughly 1.5 percent of GDP — well within the range of what it has been able to achieve in the past. The upfront costs would be greater, but so would the chances of success.