07 September 2015

VoxEU: Breaking the Greek debt impasse

Greece needs debt restructuring. Yet, to get debt reduction, the Greek government is required to implement structural reforms. This column proposes a way to square the circle by introducing a Structural Reform Index in Greek loan contracts.

Greek debt restructuring and structural reforms

Greece needs debt restructuring. On this, a growing chorus of voices is agreed (Manasse 2015, Taylor 2015). Even the IMF (2015) now acknowledges that Greece’s debt is unsustainable. Restructuring is required, it now insists, for the workability of the third programme between the country and ‘the institutions’ that is currently being finalised.

Yet, the German government refuses to agree to debt reduction absent evidence of prior structural reform. Debt reduction should be a reward, it insists, for prior action on the structural front. If it is offered now, the Greeks will be let off the hook, and the incentive to proceed with hard structural measures will be blunted. 

Greek politicians – and many of their voters – insist to the contrary that they deserve a credible promise of debt reduction and restructuring now. Absent such a promise, they are reluctant to commit to painful structural reforms. In the presence of a crushing debt burden, they argue that they have already suffered enough. 

Others like the IMF, putting considerations of fairness aside, imply that the third adjustment programme is doomed to fail absent an up-front commitment to restructuring. The Fund appears to be prepared to condition its financial participation in that programme on a German concession on the issue.

An agreement to a structural reform index – a way to square the circle

There is an obvious way of squaring this circle. Greece and its creditors should agree to include a ‘Structural Reform Index’ in Greek loan contracts and use it to link future terms of debt service to progress on structural reform.   

With this agreement, interest paid to the creditors would decline or repayment terms would be extended with the number of structural measures taken by Greece. If Greece were to implement more reforms, future loan terms would then be made even less burdensome. 

[...]

Including additional features to the proposal

While the central feature of the proposal is the linkage of debt relief to progress in structural reforms, the resulting instruments could be further enhanced by the inclusion of additional features, including: 

• GDP-indexed value recovery. [...]

• Pullback clause. [...]

• Bond conversion option and debt swaps.[...]

Feasibility of the proposal

So is all this feasible?  In Eichengreen et al. (2015b) we provide a detailed term sheet for converting the Greek government’s eligible debt to the EU into Structural Reform Indexed loans. Using the second agreement between Greece and the Troika for illustrative purposes, we show exactly how structural reforms could be scored for purposes of these instruments. Finally, we provide a financial analysis of the proposal, showing how much debt reduction Greece will receive in present value terms. Greece is in urgent need of a confidence shock that would reset expectations, reverse capital outflows, and revive investment. A comprehensive resolution to the country’s debt problem could impart just such a shock. But a comprehensive resolution requires Greece and its creditors to think outside the box. To them we say, the ball is in your court.

Full article on VoxEU

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