A Market-Friendly Debt Buyback?
It took just a few months after the completion of the biggest-ever sovereign debt restructuring in history, known as PSI (Private Sector Involvement), for policymakers and others to see what the markets have been saying all along: that the Greek public debt has not become sustainable.
Unfortunately, most decision-makers in the European Union now appear to be leaning toward a writedown of Greek debt in public hands, which is hardly the optimum solution.
PSI turned out to be a big success as far as high investor participation and smooth execution was concerned, but it failed in the most critical test: To provide significant debt relief and convince the markets that the Greek public debt was sustainable, unleashing a series of positive reactions from investors and others that would contribute to the stabilization of the economy.
Debt relief should have amounted to more than 100 billion euros, or 50 percentage points of GDP, after the completion of PSI. This, however, did not happen for specific reasons: Greece is still running a primary budget deficit projected close to 1 percent or 2 billion euros this year. In addition, the so-called snowball effect emanating from the difference between the average nominal interest rate and GDP growth continuous to burden the debt-to-GDP ratio.
The same holds true for tens of billions of euros in official funds/bonds destined for the recapitalization of Greek banks and paying off state arrears. Also, intergovernmental bond holdings held by pension funds and others are not included in the general government debt calculation, making the debt reduction under PSI smaller. Social security funds saw their holdings of more than 24 billion euros cut by more than half in value under PSI.
So, PSI did not provide the kind of debt relief that the markets and others wanted to see in order to believe that Greece could, under some normal assumptions, significantly bring down its debt ratio from the start, and also to benefit from the lower average lending rate and the light redemption schedule in the years ahead due to the extension of maturities.
It is clear that the worse-than-projected performance of the Greek economy in 2012 and its likely underperformance next year necessitates changes to the sustainability analysis of the Greek public debt. The lack of satisfactory progress in the privatization program means the positive impact on the debt from this source may not fully materialize. Also, fiscal slippage cannot be ruled out for sure in 2013 and 2014 if the economy continues to shrink. The situation becomes more nebulous if one assumes a one- or two-year extension of the Greek economic adjustment program wanted by the new coalition government.
So, the goal of pushing the debt-to-GDP ratio down to 120 percent of GDP in 2020 from 165 percent in 2011 envisaged by the IMF is difficult to attain and will require additional debt relief, in order for the Greek debt to be deemed sustainable.
There is already talk that the Greek bonds held by the ECB and other national central banks will have to be restructured to make it possible. Many had criticized the ECB for refusing to take part in PSI but now the issue is coming back since writing down bilateral EU loans to Greece is politically very sensitive. The ECB had refused to take part in PSI, arguing that it would amount to direct state funding, which is prohibited by its charter and runs contrary to the tradition of Bundesbank, the German central bank, after which it is modeled.
Assuming that the ECB’s Greek bond holdings amount to 45-50 billion euros, a 53.5 percent haircut along the lines of PSI, would have provided debt relief of 24-26.75 billion euros. This may be enough to bring the Greek debt ratio down to 120 percent of GDP by 2020 under the new more ominous assumptions about the economy -- privatizations etc. -- but we think it will still not be enough for the markets.
To change the game, policymakers must be willing to do more -- assuming Greece honors most of its commitments under the second financing package. It does not take a genius to see that this can happen without compromising the ECB’s mandate.
As others and we have suggested in the past, the ECB can transfer its Greek bonds to the EFSF or the new permanent mechanism, ESM, at the average price bought by the EU central banks, allegedly between 70 and 80 percent of the nominal value. This way the ECB will not lose money on its Greek bond holdings. Moreover, the EFSF or the ESM can extend a long-term loan to Greece at a reasonable interest rate that will be used to buy the same bonds from them at the same price or lower. This way the country will be able to cut its debt by cancelling the bonds of a higher nominal value.
Since this exercise will not be big enough to provide significant debt relief -- it would save just 10 billion on bonds with a nominal value of 50 billion euros, which undergo a 20 percent haircut -- the same entities could provide Greece with a bigger loan to engage in debt buyback or they could do it themselves and swap the savings to Greece.
This is a market-friendly way to make the Greek debt sustainable in the eyes of the markets. Of course, Greece will also have to do its part by meeting the fiscal targets and modernizing its economy.
All-in-all, a market-friendly debt buyback at the current beaten-down prices of Greek bonds is the best way to cut the public debt significantly and create the conditions for a turnaround in the local economy with positive results for the eurozone. Whether political wrangling and myopia will again stand in the way remains to be seen. However, it looks as if this is the best way to get the ECB out of the difficult position of writing down its holdings, making the Greek debt sustainable and reducing the likelihood of contagion, with a visible improvement on risk bond premiums in the euro periphery.
Ekathimerini reports that Greece’s three coalition leaders are to hold a crucial meeting on Monday that is likely to decide what form the 11.5 billion euros of spending cuts for the next two years are likely to take:
It appears that Prime Minister Antonis Samaras, PASOK leader Evangelos Venizelos and Democratic Left chief Fotis Kouvelis have agreed that the measures should not include a further cut to civil servants’ salaries, thereby ending the 13th and 14th monthly payments, nor the imposition of a 1,500-euro per capita ceiling on healthcare coverage. Instead, it will raise from 5 to 15 euros the cost of a visit to a public hospital for treatment.
One of the areas where the three leaders have yet to agree is on the rise in the retirement age from 65 to 67. This would save about 1 billion euros over the next two years. Venizelos and Kouvelis suggested trying to find alternative measures of equal value.
The leaders also have to decide where to set the limit on how much retirees who have basic and auxiliary pensions can receive per month. It is likely that the ceiling will be placed between 2,300 and 2,500 euros. There is also a proposal to reduce any pensions above 1,400 euros by 10 percent but Venizelos wants the reduction to be only on the amount that exceeds this level, rather than on the total retirement pay.
Among the measures that look certain to be included in the latest cost-cutting package is a 22.7 percent reduction to the lump sum civil servants receive when they retire. Private sector workers who draw their pensions from state-backed funds could also be in line for a cut. Also, public hospitals will be instructed to increase their use of generic drugs to 66 percent of the total medicines they use by 2014.
The government sees a quick agreement on the fiscal measures as the first step to rebuilding trust with its lenders. “The road ahead is long and demands patience and persistence so we can make up for lost time,” Alternate Finance Minister Christos Staikouras told Sunday’s Kathimerini.
“Greece cannot be saved; that is simple mathematics,” Michael Fuchs, deputy leader of the parliamentary group of Chancellor Angela Merkel’s Christian Democrats told business magazine Wirtschaftswoche. ”The government has neither the will nor the means to implement reforms.”
Germany's patience is wearing thin. The Telegraph reports that Wolfgang Schäuble, the German finance chief, said no further concessions can be made to Greece as he prepared to meet US Treasury Sectretary Timothy Geithner:
At the meeting with Mr Geithner on the German island of Sylt, the two will discuss the US, European and global economies" as growth slows around the world.
The US finance chief will later meet European Central Bank President Mario Draghi, who last week pledged to do all with the his remit to protect the euro after rising fears that Spain will need a full sovereign bail-out.
Both meetings will be closed to the press.
The US economy grew at its slowest pace in a year in the second quarter, weighed down by nervous consumers, the escalating euro-zone debt crisis and worries of slowing growth in China. Figures last week showed the US economy grew at 1.5pc compared with 2pc in the first quarter.
America also faces the threat of a "fiscal cliff" later in the year when Bush-era tax breaks end and $1.2 trillion of spending cuts start.
In the eurozone, Germany is standing firm despite increasing pressure to relax its stance on using the ECB to buy bonds or act as a lender of last resort to help stem the crisis in the single currency, particularly in Spain where borrowing costs are at unsustainable levels.
If Spain, the eurozone's fourth biggest economy and the world's 12th, loses affordable market financing the next domino at risk of falling is Italy - the euro zone's third biggest economy and a member of the G7 group of big wealthy nations.
Many regard September as a "crunch time" for the euro. In that month a top German court rules on the new eurozone rescue fund, the anti-bailout Dutch vote in elections, Greece tries to renegotiate its financial lifeline, and decisions need to be made on whether taxpayers suffer huge losses on state loans to Athens.
Despite denials last week, Reuters reports that a eurozone official said Madrid has now conceded that it might need a full bailout worth €300bn from the EU and IMF if its borrowing costs remain unaffordable.
Greece is compounding the problems as it struggles to implement the necessary reforms to improve its finances and economy. This raises the fear that it may need more time, more money and a debt reduction from eurozone governments.
Mr Schäuble told Germany's Welt am Sonntag newspaper on Sunday that the current bailout plan for Greece was already "very accommodating", adding: "I cannot see that there is any room left for further concessions. The problem did not arise because the programme had faults, but rather because Greece did not implement it fully enough."
He said it was not helpful now to speculate about giving Greece more time or more money.
"It is not a question of generosity. The question is rather, is there plausible way for Greece to manage this."
He also ruled out a further debt writedown for Greece, saying it would "only destroy trust".
Greece is experiencing its Great Depression but the truth is there is no political will whatsoever to introduce meaningful cuts to the bloated public sector, cut red tape to spur foreign investment and put everything on the table, including deep cuts to the defense budget (not part of 'austerity' measures because this benefits German, French and US defense contractors and allows Greek politicians to get rich off bribes from defense contracts).
Everything in Greece is overly-complicated because the political and industrial elite want to maintain their power even as the economy sinks to a new abyss. According to Troika, Greece can't pay its debt:
Greece is not likely to be able to pay its debts, meaning the twice-bailed-out member of the euro zone will have to restructure about $240 billion of sovereign debt, European Union officials told Reuters on Tuesday.EU leaders are also to blame as they seem incapable of addressing this 'debt crisis' (really a jobs crisis) once and for all. Mr Schäuble talks a tough game but the reality is German Chancellor Angela Merkel’s export machine is generating far more in revenue than her anti- bailout voters are committing to euro-crisis fighting as the weakening currency adds to the country’s competitive edge:
Although the officials, who are part of the so-called Troika that includes the European Central Bank (ECB) and the International Monetary Fund, won't finalize the results of their inspection of Greece's debt-choked economy until next month, their conclusions are already clear.
Prospects of euro zone members or the ECB being willing to bail out Greece yet again appear remote if not nonexistent, especially since the Greek economy is expected to contract by a massive 7 percent this year and Greek officials have not been able to make progress in fixing the 3-year-old crisis.
"Greece is hugely off-track," one of the officials told Reuters. "The situation just goes from bad to worse, and with it the debt ratio."
German exporters are enjoying a 100 billion-euro ($122 billion) annual advantage amid the turmoil, said Nathan Sheets, chief international economist at Citigroup Inc. (C) in New York. That’s more than 10 times the 8.7 billion euros the country is contributing this year to the rescue fund being set up.
The figures underscore the benefits to Europe’s biggest economy of Merkel’s austerity-first strategy, which channels her voters’ doubts about propping up debt-laden countries. Her approach has drawn criticism from policy makers around the world and pleas for easing from southern Europe, where bond spreads have climbed to euro-era records amid concern about whether the 17-nation currency region can hold together.
“Do they care? I don’t think so,” David Buik, a market strategist at Cantor Index in London, said in a July 13 telephone interview, referring to German policy makers. “It’s dog eat dog out there. It is a question of shore up the dams and do what we can for ourselves.”
Of course they don't care! Germans are just as guilty as anyone in this euro mess. In fact, Merkel has knowingly adopted an 'austerity first' strategy precisely because it benefited the German export machine (good in the short-run, longer-term this is a disastrous policy).
Below, former US President Bill Clinton visits Athens with Greek American businessmen to support the new government in the crisis-crippled country, and warns that constant pressure by rescue creditors is counterproductive. Greek PM Samaras says his country is going through its version of the Great Depression.
And European Commission chief Jose Manuel Barroso arrived at the prime ministerial headquarters for talks with the Greek PM Antonis Samaras. Spokesman for the Commission Antoine Colombani told reporters the assessment on Greece's ability to sustain its debt will not be finalized until inspectors from the IMF, the European Central Bank and the European Commission return in September to look into the country's progress.