Europe’s strong statement to keep Greece in the euro
The Troika has finally reached an agreement regarding Greece. A second debt restructuring was almost necessary in order to bring Greece back on a sustainable debt path. However, due to the particularity of the euro area a haircut of principal was not an option. Two-thirds of the Greek public debt are currently detained by public entities (member states, the EFSF/ESM and the ECB). A haircut on this debt might have been interpreted as an illegal financing of a member state. Other ways have therefore been found to alleviate Greece’s debt burden.
- A lowering by 100bps of the interest rate charged to Greece on the loans provided as part of the aid package;
- A deferral of interest payments by Greece on EFSF loans by 10 years;
- An extension of the maturities of the bilateral and EFSF loans by 15 years;
- The profits made by the ECB on its holdings of Greek bonds will be passed back via governments to Greece;
- Greecewill proceed to a debt buy-back of the bonds still detained by private creditors.
- Postponement of a primary surplus target of 4.5% of GDP from 2014 to 2016
- Postponement of the debt targets: 175% of GDP in 2016, 124% in 2020 and below 110% in 2022.
The agreement allows the release of the €31.5bn tranche and guarantees financing for 2012 and 2013.
The first decision is a courageous measure as some countries will lend to Greece below their own financing cost. So it looks like a permanent transfer.
The 100bps cut will bring interest rates on loans to 50bps plus interbank interest rate. This measure combined with the deferral on interest payments on EFSF loans and repayment of the ECB profits mean that debt servicing on two-thirds of the Greek debt will be brought close to nothing.
The final third is projected to be bought back at a huge discount (30 cents per euro). If it is a success (but that is a big if), the whole set of measures will bring debt servicing close to marginal costs. At this point, the only remaining problem will be roll-over. But some sort of euro area guarantee could easily be imagined in order to issue new debt subject to these conditions.
So if all these conditions are met we could see Greece essentially financed by the official sector and brought back on a sustainable debt path whatever the debt level.
… However, some obstacles to this rosy scenario remain
With such a discount, it is far from sure whether the debt buy-back will be a success. And this is certainly a pre-requisite if the IMF is to be kept on board.
A failure of the debt buy-back will certainly create new tensions between the IMF and Europe.
Economic recovery is not in sight. Pursuit of current austerity is challenging and will weaken the government. Social unrest and political instability may well derail the whole process.
Now that an agreement has been reached on Greece, other periphery countries may well ask for similar conditions. As a result, the focus may shift from Greece to Portugal and Ireland. Some volatility on their interest rates is likely.
In spite of all the problems that remain, the agreement underlines the EU authorities’ commitment to keeping Greece in the euro area.