24 September 2015

VoxEU: Greek debt remains unsustainable: Here is why

Without further debt relief, Greece is unlikely to have market access after 2018. Under reasonable assumptions, its debt ratio will likely not decline, and the financing burden will increase again.

Greece’s market access in 2018

After 2018, Greece has to access the market. The current package for Greece, the third in a row, will cover Greece’s financing needs until 2018. Are private investors willing to lend to Greece against an interest rate that the country can afford to pay over longer periods of time? If so, the country can manage its own financial needs. However, if there is substantial risk of Greece not meeting these obligations, then lenders will not be willing to extend these loans.

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Options for lowering the Greek debt burden to European countries

There are four often-mentioned options for lowering the current Greek debt burden to European institutions. The first is a haircut of 30% on the financial claims on Greece. This substantially lowers the average debt level, the financing burden and the risk of both ending up higher.

The second alternative to reduce the interest rates payable by Greece to the creditor’s cost price. This has the largest impact in the first few years of such loans, when the amount lent is the highest. This also has a positive impact on financeability of the Greek debt, but less so than that of a haircut.

The third alternative is to extend the maturity dates of the loans with 40 years. The impact on the debt level materialises later than under interest rate reduction, but over time the results are comparable. The impact on the financing burden is more favourable than under interest rate reduction, and there is less risk of it ending up with substantially higher levels.

The fourth alternative is to allow postponement of interest rate payments. This in particular reduces the financing burden in the short to medium run.

Finally, as an alternative to debt relief, a fifth option exists that does not involve losses to public lenders: the European institutions could provide guarantees on new Greek debt to private lenders. This reduces the risk of the debt level and financing burden becoming higher.

Concluding remarks

From this analysis, two lessons can be drawn.

• First, in the political arena, a haircut may be very different from interest rate reductions and maturity extensions, but from the perspective of investors, they are just alternative ways to achieve comparable debt relief.

All options free up fiscal space that can be used to service new debt or to reduce the debt level and all options reduce the risk of ending up with substantially higher debt ratios and financing burdens.

• Second, with respect to fiscal sustainability, debt relief can be regarded as an alternative for higher surpluses in the long term (Mody 2015).

To achieve the same results in terms of financeability in the central pathway simulation as under the programme’s assumptions, a number of measures have to be combined, or a haircut substantially larger than 30% of the debt to European partners must be engaged in.

It is with these two insights that policymakers have to confront the question of debt relief. Two questions have to be answered there: How much debt relief is necessary, and what kind of debt relief? The amount of debt relief is a function of the primary surplus that Greece can credibly commit to over the coming decades. Some relief is likely to be necessary. Eichengreen and Panizza (2014) argue that Greece cannot credibly commit to a 3.5% primary surplus. The second question is the timing and form of debt relief. As argued by Blanchard (2015), there is a balance between keeping the incentive to reform and permanently solving the debt issue. Postponing debt relief keeps the pressure to reform high, but does not create room for growth and investments that private investors would like to see, while fast debt relief creates such room, but also reduces the pressure on the need to reform – with possible negative effects for the budgetary policy in the long term.

Full article on VoxEU (with charts)

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