The coming Greek debt restructuring;
In the event of a Greek departure from the Eurozone, a default on both official sector debt and debt held by the private sector would very likely occur. For the foreseeable future, a more likely outcome is that Greece remains in the Eurozone. The recent tentative agreement between Greece and its international creditors to negotiate a third financial support programme, makes it more likely that in the near term Greece will avert the adoption of a new currency to replace the Euro. However, for the programme to work, some debt restructuring appears necessary.
The aim of the programme is to restore fiscal sustainability, financial stability and long-term growth, and bolster market confidence, so that Greece can return to the private capital markets to meet its funding needs. Importantly, a recovery is needed to restore macroeconomic stability. If the economy does not recover, the debt burden will inevitably continue to increase. The Greek Parliament has already approved two rounds of fiscal, legislative and structural measures required by the creditors. In return, recent interim financial support from the European Stability Mechanism (ESM) and European Financial Stabilisation Mechanism (EFSM) has allowed Greek banks to reopen, some capital controls to be relaxed, Greece to repay the ECB and to clear its arrears to the IMF.
As the terms of the three-year EUR 82-86 bln ESM loan facility are being debated, some form of debt restructuring is also being considered. If a restructuring occurs, it would likely only involve official sector loans. This contrasts with the 2012 restructuring, which included both haircuts on private bonds and the extension of maturities and deferral of interest on official sector debt. So far, the design of a second restructuring has yet to be determined. Nevertheless, there are three reasons to expect a restructuring to be forthcoming.
1. The debt burden is unsustainable
DBRS shares the widely held view that Greece’s debt burden is unsustainable. This is as much a function of low growth prospects as it is of debt service payments: without a return to sustainable growth Greece’s debt burden will only increase. The damage to the economy after six months of negotiations, two missed payments to the IMF, three weeks of capital controls, a popular referendum, and an abrupt acceptance by Greek negotiators of deep adjustment measures has been significant.
GDP is expected to decline this year between -1.0% and - 4.0%. The extent of the deterioration will likely depend on the effect of capital controls on consumption and investment, and the impact of the expenditure cuts and tax increases that Greece must implement as part of the coming programme.
The IMF estimates that even with full implementation of structural reforms, as outlined in the July 12 ‘prior actions’, Greece’s real long-term growth rate will be only 1.5%. Over the medium term, GDP is expected at 2% to 3% as the output gap closes and confidence is restored. Regarding debt service, even if the programme is fully implemented, the IMF expects financing needs through the end of 2018 to be EUR 85 bln, well above the 15% of GDP threshold deemed safe. Under this framework, even if growth resumes, public debt is expected to peak at close to 200% of GDP in mid2017, up from an already high 168.8% of GDP in the first quarter of 2015.
2. IMF restructuring
On July 30, IMF staff informed the IMF board that Greece is disqualified from a third IMF programme. The disqualification was because in their view the debt is unsustainable, and because Greece has a poor record of reform implementation. The IMF staff doubts that the existing loan facility for Greece, of which there remains EUR 16.5 bln to disburse, will achieve its original targets, or allow Greece to return to the private capital markets by March 2016, when the programme expires. Therefore, the IMF will not extend any new loans under a new programme unless it deems Greece’s debt burden to be sustainable “with a high probability.” This decision is important because both the EU and ECB have expressed a lack of willingness to extend a new support programme to Greece unless the IMF is involved.
In its most recent debt sustainability analysis, the IMF