Debunking Speculation About an Imminent Restructuring of Greek Debt

by: Polyvios Petropoulos

What amazes me about the ongoing speculation about a possible restructuring of Greek debt is that most commentators seem to miss some obvious, even self-evident, points:

1. Regarding the timing of a possible restructuring, most commentators, even those who should know better, seem to believe that it has been needlessly delayed, that it should be done now, yesterday, or at any rate the sooner the better. Among them: C. Reinhart (the well-known economist and professor) here, L. Feld (Merkel’s adviser, here), M. Lynn here, Citi analysts here, The Economist here, WSJ (editorial of April 20, 2011 here), C. Simitis (ex-PM of Greece, here), V. Papandreou (ex-minister of the Greek ruling party and member of the “economic affairs committee” here), W. Munchau (in several articles in the FT), and many, many others.

These people seem to forget, or do not realize, that

(a) A restructuring (with or without a “haircut” and/or reduction of interest) should never be done before a positive primary budget balance is reached; otherwise, the government would not be able to pay salaries, pensions and other inelastic expenses, because obviously, from that point on, borrowing in the markets would not be possible for a few years. And such budget balancing – in my opinion -- cannot be achieved by Greece before the end of 2012, at best.

(b) A debt restructuring should not take place before measures have been taken to protect Greek and European banks (recapitalization, etc.) and pension funds, who hold most of the Greek bonds, and ways have been found to minimize the risk of contagion in the EZ; otherwise the result would be catastrophic.

2. Many are criticizing the Greek government, as well as the top IMF, EU and ECB officials, for not publicly admitting that Greece will restructure its debt. Regardless of whether a restructuring or rescheduling will take place or not, such decisions should never be announced publicly in advance for reasons that should be obvious to all. In such a case, mon(k)ey markets, with their parrots and talking heads, would go wild, and would drive spreads and CDSs to even more ridiculous heights, which might then become a self-fulfilling prophesy.

Some commentators, I am sorry to say, either don’t know what they are talking about or are trying to protect and serve the interests of the speculators betting on a Greek default; I sincerely hope that this is not intentional on their part.

Is the Greek debt sustainable? A table is better than a thousand words (to paraphrase the Chinese saying), and here is a table which I have adopted and adapted from a paper (unfortunately in Greek) by K. Mariolis & Th. Papoulias on the “Dynamics of Greek Debt etc.” (here) -- in particular their table on p. 5, which I present here in a slightly simpler version in English (skipping the zero growth rate assumption, which of course is even more hopeless):



As you can see, the Greek public debt / GDP ratio is non-sustainable as things stand today, even under the most optimistic alternative assumptions about future GDP growth, average interest rate, inflation, etc., to say nothing about how the Greek economy is currently doing, which is much worse than the authors’ assumptions, or of the IMF’s projections, as readers of the daily press well know. The IMF Memorandum originally estimated 150% as the peak of Debt / GDP in 2013. The study here, however, pushes it up to 158.6 by 1915.
So what should be done? I believe that what will be needed is a combination of some or all of the following:
  • Continued implementation of fiscal consolidation, but with corrections which I point out below, until a positive primary budget balance is attained.
  • Structural reforms to restore competitiveness and export-led growth, which of course is not an easy task in the short term.
  • Solidarity on the part of its EU/EZ partners (which is the sine qua non of a monetary union), in the form of euro bonds, Brady-bond-type swaps, Uruguay-type “reprofiling”, bond buybacks, etc.
  • And, finally, when the preconditions I mentioned above have been attained, a voluntary debt rescheduling (VDR) of one form or another will probably take place.
A VDR is benign for banks, because they may continue showing Greek bonds at their nominal par value (NPV) in their balance sheets. Can it be “voluntary”? Of course it can. Who would reject an offer to swap, say, a maturing 100-euro NPV bond, currently selling in the markets for 40-50 euros, for a 100-euro bond maturing in 10 or 15 years, without any haircut, guaranteed by an EU institution, even with a slight reduction in interest rate?
I read that the International Capital Market Association and J. Cotterill (here) have certain qualms about Greek bond buybacks which – according to their unverified reports -- are already taking place. I don’t see what the problem is. If Greek bonds are being sold in the market at 40% or 50% of their NPV, anybody (person or country) can buy them, especially if he believes that this price is below fair value. This way a country may retire a part of its debt at very good terms. Similarly, corporations will sometimes buy back their own shares. And this is beneficial for shareholders or bondholders (in the case of bonds) for obvious reasons. The only ones who may have reasons to complain about Greek bond buybacks would be speculators who are betting on Greek default.
About a year ago, I posted an article titled “Truths and Myths about the Greek Crisis” here. Although many things have elapsed since then, I wouldn’t change one iota. Six months ago, I also sent a letter to the Greek PM and Minister of Finance. In it, I enumerated a number of measures that should be taken. Some of them (but not all) were adopted and announced just before Easter. Those that were adopted and were announced are: Further cuts in total public spending (which, however, are not enough) and in defense spending; privatizations; sale and/or development of the state’s real estate; and measures to combat evasion of taxes and social security contributions. The crux of the matter here is of course implementation.
But still other suggestions of mine have not been adopted, including that the Memorandum with the Troika must be renegotiated, especially with respect to reductions in the lowest private (IKA) pensions. The savings for the public budget from these pension reductions would be on the order of 600-700 million euros, when unpaid social security contributions are over 7 billion euros, and the government can find a myriad other alternative sources of funds.
Finding alternative sources of funds with an equivalent effect is allowed by the Memorandum, according to recent statements by government officials. The disproportionately adverse impact of reducing these pensions on consumption and GDP is due to the fact that these pensioners have the highest marginal propensity to consume, or in other words, they spend (inevitably) their total pension on food and other basic items, thereby supporting the real economy by increasing sales of private companies, GDP and public revenues, more than any other income group.
I was also saying that the political “elite” must start from their own bunch, so as to give people a good example: Reduce the number of members of parliament to 100-150, reduce the number of ministries to 7-10 (Switzerland has seven), make the parliamentarians’ pension scheme similar to that of any other Greek citizen (they now draw a pension after only two legislative mandates of maximum eight years in total), reduce their salaries and extras and legislate draconian penalties for corruption of public officials, ministers and parliamentarians, with a minimum imprisonment of 10 years without the possibility to pay and get out, and without the statutory limitations that are now in place for MPs. The wealth of politicians when they entered public life must be checked and compared with their wealth today, and they must be asked to account for the difference.
It has been estimated that the drastic reduction of corruption will lower the deficit at least by half. Some have estimated the cost of corruption in Greece at 8% of GDP. You may study and imitate the special agency which was set up for this reason in Hong Kong (ICAC), and has had almost total success in tackling corruption there. The other half of the deficit can be eliminated with the equally draconian criminalization of serious tax and social-security contributions evasion. The underground economy has been estimated at approximately 30% of GDP. The underground economy (as well as the high tax evasion figures) is partly due to the fact that Greece has one of the greatest percentages of self-employed citizens in the developed world. If only half can be captured, the extra public revenue will be at least 5% of GDP. The real estate properties owned by the state, which can either be developed, leased or sold, have a market value approximately equal to the entire public debt. The unpaid tax obligations of Greek citizens are equal to the total deficit (32 billion euros). An equal amount of outstanding tax obligations is pending in the courts. But no need for more taxes and for so-called “objective criteria” in determining the tax a citizen must pay, which are totally arbitrary. In fact, the 20 or so taxes on real estate and construction (which is the locomotive of the Greek economy) must be reduced. Some privatizations were recently announced, but no concrete steps have been taken so far. The 110 tonnes of gold are in the vaults of the Bank of Greece doing nothing. And the oil and gas reserves in the Aegean Sea ... I better not talk about them.
The "party" and all sorts of fanfare, unfortunately, continue in the wider public sector (ministries and other public services, utilities, local authorities, public insurance agencies, public hospitals, etc.), despite some reductions in expenditures which were made recently. There must be an end to the limousines, the receptions, the unnecessary trips of public officials all over the world, the several bodyguards for politicians working in three shifts, who also do the shopping ... for the ministers’ home, the well-paid advisers and assistants, in particular, the idle employees and officials who were recruited in the broader public sector “through the windows” (as we say in Greek for nepotism), the many ghost organizations, etc. There is no reason why public employees should be employed for life. And the rule “one hired for every five who leave service" must be changed to “nobody hired -- period."
It is now well-known that the debt dynamics are such that when the average rate of interest of the debt is greater than the GDP % growth (r>g), then the debt / GDP ratio rises continuously and leads to the well-known vicious cycle, in which Greece is now. (See the study of Mr W. Buiter on the “Debt of Developed Countries” and the more recent one on “Greece and the EMU” by W. Buiter, et al. here.) Some economists (A. Alesina and S. Ardagna, among others) have been saying that some countries have supposedly managed to achieve expansionary fiscal stabilization and adjustment, without renegotiating their debt. But these cases were in completely different circumstances than Greece’s today: This was in times of global economic prosperity, declining level of interest rates and refers to countries with their own independent monetary policy and their own currency (and therefore capable of currency devaluation).This has now been recognized even by the IMF in their most recent WEO, Ch.3 here. As P. Krugman has put it with a tautology, “contraction is contractionary." And the front-loaded fiscal consolidation, like the one imposed on Greece, is especially so.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.