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Who is right?
Holding a national referendum on a highly technical document on debt sustainability is indicative of the confusion among Greek (and EU) politics in the midst of a never-ending crisis. It is also indicative of some confusion over what debt sustainability analysis tells us.
How could we have conflicting conclusions on the sustainability of Greek debt by credible analysts with access to the same data? For instance, Paul De Grauwe argues that the “Greek debt is sustainable” (De Grauwe 2015), whereas the recent IMF report finds that the “debt could not be considered sustainable” (IMF 2015).
One explanation stems from different assumptions about growth and debt refinancing rates. [...]
Conclusions
Policymakers need to consider tail risk in debt sustainability analysis. The tails of the distribution hold information that can make or break the conclusions of their analysis.
An application to the case of Greece confirms that its debt is unsustainable. Sustainability is restored either with an upfront nominal value haircut of 50%, or interest rate concessions of 70%, or maturity extension by about 10 years. Our findings are in broad agreement with the latest IMF analysis, and provide additional credibility since they hold true with high probability. However, it is worth noting that this analysis was carried out using 2014 data and, hence, it shows that the IMF erred in declaring debt sustainable in 2014. Our analysis, carried out in March 2015, anticipated the IMF’s 2015 analysis and was not affected by the policies of the new Greek government. Hence, the IMF cannot blame the debtor for the revision of its debt verdict from sustainable to unsustainable. No matter how misguided the negotiating tactics of the Greek government might have been, debt was unsustainable before they came to power.
A recommendation
What does this analysis tell us about the Greek saga?
With high probability, we can say that the country needs debt relief. This can be in the form of interest rate concessions and the rescheduling of debt obligations. However, debt relief should not be postponed to some indefinite future. Adopting the tactical view that debt is sustainable fails for two reasons. First, the country does not see any light at the end of the tunnel and the politics of reform worsen. Ownership of the programme is key to its success and it is hard to claim ownership of a programme that succeeds in its tactics but fails in its strategy. Second, much desired foreign direct investments cannot be attracted to a country during the programme if it is highly probable that the country cannot graduate from the programme. The IMF is right to refuse to join a programme that does not include debt relief.
Greece and its creditors should now ‘bet on the future’. [...] Instead of aiming for an agreement now, the differences of opinion should form the core of a contingent contract for debt relief. Withholding the disbursement of funds without prior actions is the stick that creditors wield. Contingent debt relief is the carrot; contingent on a successful first year IMF review and the debt-to-GDP ratio remaining above the current level, a pre-specified debt relief clause becomes effective. Our analysis shows what this clause could entail.