Greek Debt’s Gordian Knot Remains Tied – Analysis

By Ramesh Jaura

A cocktail of responses to the Greek restructuring deal is lending an aura of ‘love, peace and harmony’ – as the German saying goes – to the marathon run to resolve the multi-layered debt crisis. But hardly anyone is convinced that the finish line has been reached.

Open Europe, an independent think-tank calling for reform of the 27-nation European Union (EU), in fact warns that the deal constitutes “a small step forward, but it could prove to be a pyrrhic victory.” Because the debt relief for Greece is far too small: As a result, another default could be around the corner. At the same time, the austerity targets are far from realistic and rather suited to kill growth prospects.

Furthermore, Greece’s debt is set to end up being almost completely owned by Eurozone taxpayers. By exempting official taxpayer-backed institutions from the write-down, the deal has created a distorted, two-tier bond market.

As the London-based think-tank points out, the future of the latest bailout package is far from certain because of upcoming Greek elections at the end of April. Uncertainty arises from the fact that the two main Greek political parties – New Democracy and Pasok – have been losing ground to both far-left and far-right.

But the hope is that these two leading parties will manage to form a coalition government with a clear majority in parliament. Even if they do not bag the majority of votes, they may still have a majority of the seats due to the electoral law in Greece.

Nevertheless, it promises to be a close run election and without a strong majority in parliament, every future vote on new austerity measures, of which there will be many, will be a hard fought battle – not conducive to political stability.

A post-election government in Athens will indeed be faced with a herculean task. Under recent proposals, the total level of budget cuts Greece is expected to undergo stands at a massive 20% of GDP (Gross Domestic Product) by 2013.

Historically, no country has ever gone through such a huge fiscal consolidation – successful or otherwise – especially without the option of currency devaluation. For example, extensive fiscal consolidation in Ireland during the 1980s and 1990s resulted in ‘only’ 10.6%.

Open Europe’s scepticism that Athens is highly unlikely to meet its debt targets by 2020 is shared also in Germany, the largest EU funder of the bailout package. The German Finance Ministry described the high take-up rate (85.8% of private creditors had agreed to the debt swap) as an “historic opportunity” for Greece. “We welcome the fact that the private sector will, to a high degree voluntarily, participate in Greece’s stabilization.” However, German Finance Minister Wolfgang Schaeuble, said he sees no reason for being “euphoric”.

Simple arithmetic shows that combined with the poor growth prospects due to continuous austerity, Greece will almost inevitably need either another bailout in three years’ time, or be forced to default on its outstanding debt.

Another significant aspect of the deal is that it sets the Eurozone up for a political row involving Triple-A countries. At the start of 2012, 36% of Greece’s debt was held by taxpayer-backed institutions – the European central Bank (ECB), International Monetary Fund (IMF) and European Financial Stability Facility (EFSF).

By 2015, following the voluntary restructuring and the second bailout, as Open Europe rightly points out, the share could increase to as much as 85%, meaning that Greece’s debt will be overwhelmingly owned by Eurozone taxpayers – putting them at risk of large losses under a future default.

“Therefore,” says Open Europe, “the (latest) deal may have sown the seeds of a major political and economic crisis at the heart of Europe, which in the medium and long term further threatens the stability of the Eurozone.”

Head of Open Europe’s Economic Research Raoul Ruparel further explains: “With the use of CACs (Collective Action Clauses) Greece has entered a coercive restructuring or default – something which Greece and the Eurozone have spent two years trying to avoid.

“While the financial markets can handle the triggering of CDS (Credit Default Swap) that this will entail, at some point serious questions need to be asked over the amount of time and money which policymakers have wasted on what has ultimately amounted to a failed policy. Instead, Greece should have undergone a full restructuring combined with a series of pro-growth measures.”

Ruparel appreciates that “there will be plenty of optimism in the corridors of power around the Eurozone . . ., some of it justified because Greece has avoided “a chaotic and unpredictable meltdown.” However, he warns, this deal could end up being “a pyrrhic victory.”

In a similar vein, the Wall Street Journal reports: “There was a general sigh of relief across euro-zone debt markets as news emerged Friday (March 9) that there was a strong uptake to Greece’s €206 billion ($273.47 billion) private-sector debt restructuring, but caution prevailed as some questions remained over the deal’s implications for Greek credit insurance.”

Unimpressed by such restraint and – justifiably – keen to spread optimism, the Greek government spokesman Pantelis Kapsis said: “I think it’s a historic moment. It will allow us to eliminate more than €100 billion in debt.” Finance Minister Venizelos also thanked creditors “who have supported our ambitious program of reform and adjustment and who have shared the sacrifices of the Greek people in this historic endeavor.”

IMF Chief Christine Lagarde Lagarde went several steps forward and declared: “Spring Is in the Air.”

That emotion was in part shared by U.S. Treasury Secretary Timothy Geithner, who told public broadcaster PBS: “People here in the United States and around the world can be more confident now that Europe is not going to cause a huge amount of damage to the global economy or to our economy.”

Deutsche Bank chairman and head of the board of directors of the Institute of International Finance (IIF), which has been closely involved in untying the Gordian knot of Greek debt, Josef Ackermann said: “The very strong and positive result provides a major opportunity now for Greece to move ahead with its economic reform program, while strengthening the euro area’s ability to create an economic environment of stability and growth.”

However, Open Europe rightly points out that the deal involved private sector bondholders agreeing to a 53.5% nominal write-down, while so-called Collective Action Clauses (CACs) will be used meaning that Greece is now technically in a state of default – precisely what EU leaders have spent two years trying to avoid. While marking a small step forward, Open Europe notes that the deal is unlikely to save Greece, and that the country is still on course for a full default in three years’ time, if not sooner.

Greece is getting a €105.4 billion write down, but taking on at least €58.7 billion in new debt straight away. The EFSF, the Eurozone bailout fund, is also taking on a further €35 billion – by issuing additional bonds – to ensure Greek banks can still borrow from the ECB.

What will this deal mean for Greece and the Eurozone comprising Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain? Open Europe’s answer is far from comforting:

The debt write-down offered to Greece is far too small to allow Greece any chance of recovery. Of the total amount (€282.2 billion) entailed in the various measures now on the table to save Greece – through the bailouts and the ECB – only €159.5 billion, or 57% will actually go to Greece itself. The rest will go to banks and other bondholders.

Greek banks have incurred substantial losses. These banks will be recapitalised, but ‘only’ by €23 billion. In contrast, to meet the 9% capital requirements set by the European Banking Authority, Greek banks could need between €36 billion and €46 billion. It is unclear if further money will be forthcoming, but questions will rightly continue to be asked about the state of Greek banks.

For the most part, notes Open Europe, Greek pension funds, which held around €30 billion in Greek debt, have seen their assets shrink significantly. Some public sector pension funds did refuse to take part voluntarily. But they are likely to be forced to do so by the CACs. Besides, it is unclear where Greek pension funds will recover their money from – the political fallout of having to cut pensions would only add to social unrest.