To restructure, or not to restructure Greece’s debt?
That is the question – alongside whether Dominic Strauss Kahn is innocent or guilty – that has been plaguing European policymakers, economists, and investors, as it has become increasingly clear that Greece is unable to make the necessary repayments on its €330 billion of outstanding debt.
Early last week, Standard and Poor’s downgraded the country’s credit rating to B, six notches into junk status. The panic over Greece, of course, is not new. It comes just a year after the EU provided the country with a €110 million bailout package – and is currently on the cusp of agreeing a €78 billion rescue package for another debt-laden southern state, Portugal.
Nonetheless, many European officials have implied that they would rather negotiate continued financing for Greece – ie, chalk up more money for yet another bailout – rather than go down the road of restructuring. In fact, Strauss-Kahn, the managing director of the International Monetary Fund, is one such European leader that has been strongly in favor of the EU and IMF providing another bailout package to Greece. His current incarceration on Rikers Island for the alleged rape of a New York hotel maid has, therefore, made the Greeks quite anxious that they could lose an important and influential ally in the ongoing debate.
But even Germany, which would likely foot the bill for another Greek rescue mission, has indicated that debt restructuring is far too risky an option, one that could be severely contagious and trigger a backlash throughout the Eurozone’s financial centers.
Similarly, at the European Parliament last week, EU Economic and Monetary Affairs Commissioner Olli Rehn cautioned, “A debt restructuring in Greece would have major consequences on the soundness of the banking sector in Greece as well as on any banks having exposure to Greek securities.” Greek banks are the largest holders of the country’s debt, with about €50 billion in government bonds, followed by the European Central Bank.
According to Eric de Souza, professor of economics at the College of Europe in Bruges, Brussels, “there has to be a new rescue package,” because any other option would drag the rest of the Eurozone down with Greece. Debt restructuring, De Souza says, is out of the question because of the dramatic effect it would have on interest rates. And, he argues, Greece’s other option – to jump ship and abandon the Euro – would have a negative “domino effect” on other countries in the monetary unit.
“In the near term, there will be a new rescue package,” agrees Nick Kounis, Head of Macro Research at ABN AMRO. Europe, Kounis argues, is not ready to face the consequences of debt restructuring. Such a move would have a “significant impact” on the whole of the European banking sector. At the same time, he explains, investors would likely speculate that other European periphery states, like Ireland and Portugal, would follow Greece’s lead. “Policy makers have the Lehman Brothers’ experience deep in their minds,” Kounis says, and are unwilling to risk that level of economic fallout.
Yet, while most economists and analysts tend to agree that restructuring could be detrimental to the Eurozone, can it actually be avoided?
Investors, who have pushed the yields of Greek two-year bonds up to a record 26 percent, are certainly reacting strongly to any and all signals coming out of Athens. The yields for 10-year bonds are well-above 15 percent, nearly two times the level they were at when Greece was bailed out last year. While de Souza calls this a “panicked reaction from the point of view of investors” that has the potential to create “self-fulfilling prophecies,” investors may have already concluded that the situation in Greece is unsustainable.
For Peter Dixon, an economist at Commerzbank in London, “some form of debt restructuring is on the cards; the question really is what kind of restructuring are we going to see?” In short, will it be unilateral restructuring on the part of the Greeks, or so-called ‘voluntary restructuring,’ whereby lenders extend loan maturities and reduce their interest rates? Dixon thinks investors would be smart to go for a voluntary restructuring, even if it means ultimately receiving lower returns, because the alternative – a full-blown restructuring – could mean no returns at all. A voluntary restructuring is the “lesser of two evils,” Dixon says.
Kounis, meanwhile, does not see the situation in such stark terms. While he agrees that a voluntary restructuring would be far less damaging, he does not see either – “soft” or “severe,” as he refers to voluntary and unilateral restructuring – as inevitable. To Kounis’s mind, if the next Greek bailout package is better planned, restructuring could be avoided all together. For example, the EU could provide lower interest rates with a new rescue package; deficit targets could potentially be “relaxed a bit to make the program less front-loaded”; and Greece could be allowed to implement its fiscal consolidation policies over a longer time period.
But even a year into the first bailout, Greece has struggled to inflict all the necessary fiscal tightening on its economy, and implement all of the required austerity measures determined by the EU. The country also has a major tax problem – in that many people just don’t pay them – and has struggled to enforce new tax evasion measures. Moreover, the general strike that occurred in Greece this week demonstrated that the country’s public sector unions remain forcefully against further austerity measures and plans to privatize some state assets – further complicating Prime Minister George Papandreou’s ability to deliver on policy pledges made to his European peers, let alone ask for more money.
As de Souza succinctly explains, the Greek public’s view at the moment is, “You must pay. I’m not going to pay.”
