Wednesday, 31 December 2014

31 December 2014: Greece, what now?

I´m being asked what I think about the current economic situation in Greece following the call for snap elections (to take place on 25 January 2015).

Simple question, simple answer: I think the same I thought/wrote in January 2014. This:

With a public debt to GDP ratio of 175% (public debt around Eur 320bn), Greece's debt burden is unsustainable. A debt restructuring unavoidable.

Given that (i) the Troika (EU, ECB, IMF) is not willing to restructure Greek debt and (ii) Greece will not be able to achieve any reasonable economic growth under such a heavy debt burden, social and political turmoil is unavoidable. The left-wing Syriza party, led by Alexis Tsipras, will win the next early general elections - taking place in 2015, the latest -, force a debt restructuring, impose capital controls, nationalise the entire banking system and lead Greece out of the Euro. Private investors, starting with Greek government bondholders, will suffer heavy losses. But leaving the Euro is the right thing to do: Greece has no chance to regain its competitiveness staying in the Eurozone. The Greek exit in turn will trigger Portugal and Spain's exit from the Euro. Possibly even Italy's. It will mark the beginning of the end of the Euro project.

This, in short, is the prevalent view among many economists, investors, leading newspapers and opinion makers. However, sometimes perception and reality are far, far apart. This is one of those notable occasions. This is why:

1. The Greek public debt burden is undoubtedly very high. But 85% of it is held by the Troika: EU, 65%; ECB, 10%; IMF, 10%. Meaning: a debt restructuring doesn't require any private sector involvement. The debt restructuring can be borne by official creditors alone.

2. There is no incentive to involve the private sector in a public debt restructuring. Why scare off private investors - who are so very much needed for a jump in investment, structural change in Greek's productive structure (via FDI) and economic growth - when (i) they only hold 15% of the total Greek public debt (ii) some of them have just put Greece back on their radar screen, (iii) the first Greek public debt restructuring back in 2011 was borne by private investors and (iv) it is much easier to sit at a table and negotiate with three creditors (EU, ECB and IMF) than with hundreds of them (private investors). Therefore, even if Syriza wins the next general elections don't expect any losses for private investors in Greek debt. Alexis Tsipras may be a populist politician, but he is not mad. He knows too well that foreign investment (and especially FDI) is needed to turn the Greek economy around and create the foundations for sustainable economic growth.

3. The 65% of public debt held by the EU had initially (2010) a 7-year maturity. It paid an interest rate of 3M Euribor +5.5%. Since then maturities have been extended and interest rates cut, leading to the following figures at the end of December 2013:

- The debt maturity is 31 years

- The interest rate on 15% out of the 65% (EU bilateral loans - Greek loan facility (GLF) - as the EU rescue fund EFSF / EFSM / ESM was not yet in place in 2010) is 3M Euribor + 0.5%

- The interest rate on the remaining 50% out of the 65% is 3M Euribor + 1.5%. More importantly, interest payments on these loans (already conceded by the EFSF) were deferred for 10 years. No interest payments are due until November 2022

Sounds good? It gets even better: in November 2012, the EU agreed to transfer every year to the Greek government the profits made by the ECB with its securities market programme (SMP) accruing to the Greek central bank. In 2013, this amounted to Eur 1.5bn. The total interest payments to the Troika were Eur 1.7bn (less than 1% of Greek GDP)

4. Currently, total interest payments on Greek public debt account (including the deferred interest payments on EFSF loans) for 3.5% of the country's GDP. This compares with 2% for Germany; 3.2% for Spain; 4.1% for Portugal; 4.3% for Ireland; 5.2% for Italy.

By the way, did the Euro make everything worse? No. At the end of 1998 (just before the Euro was launched), Greek interest payments on public debt accounted for 7.4% of GDP. For Italy, the figure was 6.1%; Portugal, 3.8%; Spain, 3.3%; Ireland, 2.2%. Except for Ireland, the lower interest rates post-Euro (and generous bail-out financing terms for Greece, Portugal and Ireland) more than offset the currently (much) higher levels of public debt.

In short: contrary to common wisdom it is not true that the Troika, led by the EU, is not willing to restructure Greece's public debt. A soft and silent Greek public debt restructuring has been under way for the past 2 years. Simply neither the EU (and especially Germany) nor Greece have been advertising it very loudly for obvious political reasons. But being silent doesn't mean being non-existent.

Is there anything missing for the Greek debt restructuring to be completed? Maybe. Namely:

a) Extending the maturities of ECB held bonds and IMF loans to over 30 years and reduce interest rates to 3M Euribor + 50bps (GLF terms) on all debt held by the Troika? No problem.

The IMF wants to get out of Greece and its money back at the end of 2016. Mr. Schäuble, the German finance minister, said during the German election campaign in the summer 2013, that Greece would need a third and last rescue package of Eur 50bn to Eur 60bn by the end of 2016. The IMF loans and ECB held bonds amount on aggregate to roughly Eur 60bn. What a coincidence, isn't it?

With the ESM replacing the IMF and ECB as creditor, consider the debt maturity extension and lowering of interest rates to 3M Euribor + 50bps (on the entire official sector held Greek public debt) a done deal. Obviously all this will be made conditional to the country continuing to implement the famous structural reforms. And obviously with the Greek government trying to soften down conditionality as much as possible while the EU trying to keep the pressure high at all times. But in the end an agreement will be reached. As usual.*

b) Extending debt maturities to 50 years for a sustainable level of public debt to be achieved? Doable, if needed.

Or is it reasonable to expect that after having extended debt maturities from 7 to over 30 years over the past 2 years, and all the effort made to stabilize the financial situation in Greece and the EU periphery, the EU will not concede Greece such a debt extension if needed? The answer can only be a resounding "no".

And now the important question: what will be the impact of (i) extending maturities to 30 years on all Greek public debt held by the Troika (remember: this means that none of this debt has to be refinanced for 30 years) and (ii) lower interest rates to a level such that Greece will be able to generate a primary surplus to pay the interests on all its public debt (held by the Troika and private investors)?

- Assuming a nominal annual growth rate of 4% over a 30 year period (30 years is a long, long time) - and with private sector held debt as a % of GDP remaining constant - Greek public debt would reach 70% of GDP by 2043

- In case of a debt maturity extension to 50 years, Greek public debt as a % of GDP would reach 45% in 2063

We can discuss all these assumptions and results. But that would be missing the point of the whole exercise. The point is to show that (i) by eliminating the refinancing needs / refinancing risk on public debt held by the official sector for 30 (or 50) years and (ii) continuing to lower interest rates to enable Greece to fully cover its interest payments with a modest primary public budget surplus, the Troika (read EU) is effectively restructuring slowly, surely and silently Greece's public debt.

The most interesting of all is that this gigantic public debt restructuring is about to make the country the best GIPS in terms of balance sheet quality. Sounds lunacy? Can't after all the same soft and silent debt restructuring strategy be followed for other countries, like Portugal, Ireland and Spain?

Yes and no. It can be done. It will be done. However, the impact will be more limited: Portugal's public debt is around 120% of GDP, but "just" 45% of it is held by the Troika; for Ireland's the numbers are 105% and 40%, respectively; for Spain 90% and less than 5%.

More importantly, Greece's comparative advantage doesn't lie on its public sector balance sheet. The key to understand why Greece is about to become the GIPS best quality balance sheet is to look at countries' private debt levels. The following chart makes things clear (note: the data is from Dec 2010, but no meaningful changes occurred in private debt levels. Only in public debt, which increased in all depicted countries. Reason for which I relieved myself from the pain of updating the chart with the most recent BIS data):

      Source: BIS / Casey Research

No, there is no mistake in the chart. And no, it's not an illusion. Your eye-sight is just doing fine: Greece is the EU country with the lowest level of private debt (household and corporate) as a % of GDP. Lower than Italy. Lower than Austria. Lower than Germany. With the public debt restructuring under way, Greece is about to become the EU country with the cleanest aggregate balance sheet (public + private). Surprise, surprise.

What about external competitiveness? Isn't Greece's lack of competitiveness at the root of its debt problems? Yes, it is. And doesn't this mean that an Euro exit is the only realistic way for the loss of competitiveness to be restored? No, it doesn't.

The loss of competitiveness has in fact been restored over the past three years. Look for yourself to what happened to Greek unit labour costs....

      Source: OECD

....and to put Greece's unit labour costs (ULC) evolution in perspective, here are two more charts:

      Source: Eurostat, ECB, Ameco, Tortus Capital

      Source: Eurostat, ECB, Ameco, Tortus Capital

Not bad at all, isn't it? And yes, Greece is now (end 2013) running a small current account surplus. Furthermore, with more than 2/3 of the Greek public supporting the Euro, exiting the Eurozone is definitely not an option any Greek politician is going to pursue.

Finally, could Mr. Tsipras force a debt haircut if he comes to power? Now that Greece is running a current account surplus - and not dependent on external financing anymore to pay for its imports - as well as a primary public budget surplus, he certainly could declare default and force a restructuring of the Troika (and especially EU) loans. From a pure financial point of view, it wouldn't make much sense: even if he obtained a 50% haircut on the EU held debt, and Greece financed itself in the market at a 4% interest rate for 10-year maturities afterwards, the Greek government would pay more in interests than it is paying now (and as much as it would pay without the 10-year interest deferral on EFSF loans). From a political point of view it might however be an attractive option: he would be deemed the national hero that liberated the Greek people from their suffocating debt burden.

Then again, in practical economic terms an haircut would only make visible and loud what is currently hidden and silent: a massive debt relief for the Greek government is taking place.


  1. Well done, well done.

    I still think there are other big risks. Your scenarios are very likely if the mainstream wins again, but I get the feeling Tsipras is somewhere close to mad and he is likely to get into real loggerheads with the EU and ECB. Greece still needs to get that next stage of bailout and restructuring and I'm not convinced he's going to be sensible enough to take it. And since he won't quit the euro and there is no way to force Greece out, the result could be a weird, messy, long-running conflict. The real danger is that Greece's political institutions are weak. They badly need the sort of boring, moderate consensus they've got to heal and get business to invest and pay taxes. With a divisive dogmatic leftist the turnaround could fall apart. At least that's my opinion.

  2. Excellent analysis. Very much enjoyed the conclusions you have presented here and will try to get it wider circulation in Greece. I am a former US Embassy Athens Economic officer living in Athens, and more than most I appreciate how hard it is to get workable assumptions to crank into your calculations. The problem I see here is that your vision of Greek debt sustainability through quiet restructuring flies in the face of SYRIZA's declared ideology of "Undeniable Debt Unsustainability." In fact SYRIZA has no unifying thread beyond the UDU doctrine and thus your analysis basically invalidates their entire economic platform. Since the average Greek doesn't have the ability to do the math, the SYRIZA objective of a massive up-front write down is about all they can understand. The media here presents any discussion of extending maturities and lower rates as a mirage believed only by simpletons. But that is Greece for you. Science, or truth, takes second place to politics.

  3. I was unable to identify myself on the previous post as other than anonymous, having found the article on a borrowed tablet. Now i can. Great work!

  4. Greece and the other debtor countries had a lot of help from the creditors... in accumulating the unsustainable debt burden.

  5. Surely the foreign creditors didn't force Greece to sign on the dotted line.......