The 10-page Greek debt sustainability report that we obtained Monday night is filled with very sobering conclusions that we highlighted in our news story that’s now up on the web.
But the document – prepared by analysts in the so-called “troika” of international lenders, the European Central Bank, European Commission, and International Monetary Fund – is filled with so much interesting data, that we thought we’d give it further airing here at the Brussels Blog.
The report, marked “strictly confidential” and dated February 15, starts with a page-long summary that includes arguably the most revealing paragraph in the entire document:
There are notable risks. Given the high prospective level and share of senior debt, the prospects for Greece to be able to return to the market in the years following the end of the new program are uncertain and require more analysis. Prolonged financial support on appropriate terms by the official sector may be necessary. Moreover, there is a fundamental tension between the program objectives of reducing debt and improving competitiveness, in that the internal devaluation needed to restore Greece competitiveness will inevitably lead to a higher debt to GDP ratio in the near term. In this context, a scenario of particular concern involves internal devaluation through deeper recession (due to continued delays with structural reforms and with fiscal policy and privatization implementation). This would result in a much higher debt trajectory, leaving debt as high as 160 percent of GDP in 2020. Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it.
Let’s unpack that paragraph. The “share of senior debt” in the first sentence refers to the fact that, once the bail-out is complete, a vast majority of Greek debt will be held by government entities, like the IMF and the ECB, so new private investors will be afraid of purchasing new bonds even in the distant future, out of fear that in a default government creditors will be made whole before they will.
“Prolonged financial support” is a euphemism that essentially means Greece is going to need bail-out money for the foreseeable future.
The next sentence is where things get really dire. The analysis suggests that the medicine being fed to Greece – trying to drive down wages and costs through austerity measures to make the Greek economy more competitive internationally – will lead to higher debt levels in the near term that may never be overcome.
Section I of the report spells out the “baseline scenario” that finance ministers were using to negotiate during their all-night meeting in Brussels Monday. Here, the economic assumptions seem pretty rosy. In a more detailed chart in the back of the report, the Greek economy is projected to shrink this year by 4.3 per cent, but rebound to flat growth next year and a relatively robust 2.3 per cent in 2014 and 2.9 per cent in 2015.
It also notes that Greek banks, which were originally thought to need €30bn in recapitalisation funds, a figure that was later raised to €40bn, will now likely need €50bn.
Then it goes onto note that the €200bn debt restructuring – which involves €100bn in losses for private investors and is known as “PSI” for “private sector involvement” – may also have unintended consequences by creating a new class of investors. The reasons for this are complex, but essentially those who participate in the deal will get new bonds that are backed by both the eurozone rescue fund, the European Financial Stability Facility, and the Greek government. Such a “co-financing structure” between the EFSF and the Greek government makes the new bonds more secure than any other bonds the Greek government are likely to issue – and thus scare off future private investors. Here is an excerpt from that argument:
[T]he proposed co-financing structure with the EFSF…essentially implies that any new debt will be junior to all existing debt. It is now uncertain whether market access can be restored in the immediate post-program years – a conclusive assessment on this issue also depends on the modality and scale of debt reducing operations required to bring the 2020 debt ratio to 120 percent of GDP.
As several news organisations reported even before the report became public, the “baseline” scenario projects Greece’s debt to get to 129 per cent of GDP without further cuts and would require €170bn in funding through 2014, or €136bn in new money. That compares badly to the 120 per cent and €130bn targets set by eurozone leaders in October. Almost buried, however, is a line that says after 2014, another €50bn in bail-out funding is likely to be needed unless further debt reductions are found.
The next section points out how even this sobering assessment is subject to “risks mostly on the downside.” A brief sampling: If Greece’s budget surplus (not counting debt payments) gets “stuck” at 2.5 per cent, “then debt would be on an ever-increasing trajectory”. While bail-out loans from the EFSF are at low interest rates because Germany is able to borrow at super-low rates, a 1 percentage point increase in German bond yields over projected low levels would push Greek debt levels to 135 per cent by 2020. For every 5 per cent of private bondholders who don’t participate in the debt restructuring, debt levels by 2020 rise another 2 percentage points. Etc.
Then comes the “tailored downside scenario” which looks at an alternate path where Greece continues to fail to implement many of the reforms eurozone officials have been asking for. Its opening paragraph is clear:
The Greek authorities may not be able to deliver structural reforms and policy adjustments at the pace envisioned in the baseline. Greater wage flexibility may in practice be resisted by economic agents; product and service market liberalization may continue to be plagued by strong opposition from vested interests; and business environment reforms may also remain bogged down in bureaucratic delays. On the policy side, it may take Greece much more time than assumed to identify and implement the necessary structural fiscal reforms to improve the primary balance from -1 percent in 2012 to 4½ percent of GDP, and concerning assets sales, delays may arise due to market-related constraints, encumbrances on assets, or political hurdles. And of course a less favourable macro outcome would itself further hurt policy implementation prospects.
No interpretation of that is needed, really. For the uninitiated, “primary balance” is when a government has more money coming in than going out, without taking interest payments on debt into account. It’s sort of the government equivalent to what businesses call “cash flow” in their balance sheets. A long and extended primary balance is what Greece needs to pay off its debt load on its own.
Under this more pessimistic scenario, Greece looks like this:
Under the tailored scenario described above, the debt ratio would peak at 178 percent of GDP in 2015. Once growth did recover, fiscal policy achieved its target, and privatization picked up, the debt would begin to slowly decline. Debt to GDP would fall to around 160 percent of GDP by 2020, well above the target of about 120 percent of GDP set by European leaders. Financing needs through 2020 would amount to perhaps €245 billion. Under the assumption that stronger growth could follow on the eventual elimination of the competiveness gap, the debt ratio would slowly converge to that in the baseline, but likely only in the late 2020s. With debt ratios so high in the next decade, smaller shocks would produce unsustainable dynamics, leaving the program highly accident-prone.
On the upside, the final section of the report includes suggestions to get the programme back on track. One would be to include the €5.5bn in interest payments private bondholders are due in the debt restructuring, which could save €5bn. Another is to lower the interest rates on bail-out loans by 0.9 per cent, which would save €500m. Including the €12bn in Greek bonds held by national central banks in the private debt restructuring, exposing them to a 50 per cent face value loss, would have little short-term savings, but could cut debt by 3.5 percentage points by 2020. And having the ECB give up profits on the €40bn in Greek bonds it holds would save another €5bn.
Taken together, the could cut Greece’s debt-to-GDP ratio by a combined 12 percentage points in 2020. Trying to find an acceptable mix of these options was why eurozone finance ministers were still deliberating during the early morning hours of Tuesday.
Oxtapus 
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