Athens may not need a debt hair­cut

If lenders take a more holis­tic ap­proach than the one pro­posed by the IMF, a so­lu­tion could be found

Kathimerini English - - Front Page - BY HUGO DIXON

ANAL­Y­SIS How un­sus­tain­able are Greece’s bor­row­ings? This ques­tion has moved cen­ter-stage af­ter the eu­ro­zone agreed on Au­gust 14 to lend Athens up to 86 bil­lion eu­ros in a new bailout pro­gram.

The eu­ro­zone is keen that the In­ter­na­tional Mon­e­tary Fund also lends money in the bailout. But the IMF thinks Greece’s debt is un­sus­tain­able and won’t pro­vide more loans un­less the eu­ro­zone gives Athens re­lief on its ex­ist­ing bor­row­ings. The snag is sev­eral eu­ro­zone coun­tries, in­clud­ing Ger­many, are re­luc­tant to cut the debt bur­den.

This isn’t some­thing that ought to scup­per the deal. The eu­ro­zone has agreed to pro­ceed with­out the IMF, in the hope that it will join in later. It will con­sider debt re­lief af­ter the first re­view of the new bailout, which could be as soon as Oc­to­ber. But it won’t agree to a hair­cut on the face value of the debt.

So there should be a ba­sis for an agree­ment. This would in­volve giv­ing Greece longer both be­fore it starts re­pay­ing its debt and be­fore it needs to fin­ish the job. But the devil will be in the de­tail, in par­tic­u­lar over how to mea­sure debt sus­tain­abil­ity.

Var­i­ous ap­proaches

The tra­di­tional ap­proach, look­ing at debt-to-GDP ra­tios, is not suit­able for Greece be­cause its bor­row­ings are mostly on con­ces­sion­ary terms. The eu­ro­zone loans al­ready have long grace and re­pay­ment pe­ri­ods, as well as ex­tremely low in­ter­est rates. A crude debtto-GDP ra­tio – which, in Greece’s case, is ex­pected by both the eu­ro­zone and IMF to peak at about 200 per­cent – doesn’t take any ac­count of these ben­e­fits.

An al­ter­na­tive would be to look at the present value of Athens’s debt – what its to­tal fu­ture debt pay­ments are worth in to­day’s money. The Euro­pean Sta­bil­ity Mech­a­nism, the eu­ro­zone’s bailout fund, says that all the con­ces­sions so far given to Greece have re­duced the present value by the equiv­a­lent of 49 per­cent of GDP. If one sub­tracted that from the head­line ra­tio – as­sum­ing, for sim­plic­ity, that all the other debt is kept at face value – Greece would be left with 150 per­cent of GDP.

One can also cal­cu­late the present value of the new 86-bil­lion-euro loans, which will pay in­ter­est at only 1 per­cent and have an av­er­age ma­tu­rity of 32.5 years. The present value of that loan is around half its face value.

By giv­ing Athens such gen­er­ous terms, the eu­ro­zone has al­ready given it fur­ther debt re­lief of around 40 bil­lion eu­ros. Sub­tract that and its bor­row­ings would be un­der 130 per­cent of GDP – still high but not out of line with other in­debted Euro­pean coun­tries such as Italy.

Although present value cal­cu­la­tions are use­ful, they are ex­tremely sen­si­tive to the as­sumed dis­count rate – a guess at what Greece would pay on its loans in nor­mal con­di­tions. That’s why it is im­por­tant to look at other yard­sticks.

Gross fi­nanc­ing needs

The one in­creas­ingly fa­vored by both the IMF and the eu­ro­zone is gross fi­nanc­ing needs. This mea­sures how much a coun­try needs to find each year to pay in­ter­est and re­pay debt as a per­cent­age of its GDP. It looks at a gov­ern­ment’s debt bur­den from a cash flow per­spec­tive.

The IMF says a coun­try like Greece shouldn’t have fi­nanc­ing needs above 15 per­cent but, in fact, its needs are pro­jected at more than that.

Again, this is use­ful but not enough on its own. One prob­lem is that the IMF hasn’t pub­lished any re­search that val­i­dates the 15 per­cent fig­ure. It merely states this is the magic num­ber for emerg­ing mar­kets, while ad­vanced economies can get away with 20 per­cent.

The IMF is im­plic­itly treat­ing Greece as an emerg­ing mar­ket. Although this is rea­son­able in the midst of the cur­rent cri­sis, it may not be the right way of look­ing at the coun­try in the fu­ture. Af­ter all, if the bailout works, Greece will even­tu­ally be­come a rea­son­ably ad­vanced econ­omy and may then be able to sup­port higher fi­nanc­ing needs a decade or so from now.

Another prob­lem is that, if the IMF’s num­bers are cor­rect, other coun­tries may need debt re­lief. Por­tu­gal’s fi­nanc­ing needs will be 20.1 per­cent of GDP this year, ac­cord­ing to the IMF.

Gross fi­nanc­ing needs also lump in­ter­est and debt re­pay­ments to­gether. This is too crude. Af­ter all, a coun­try that just needs to re­fi­nance its debt will find it eas­ier to raise funds in the mar­ket than one that needs to bor­row to pay in­ter­est.

Holis­tic view

This is why it is also im­por­tant to look at a gov­ern­ment’s in­ter­est pay­ments as a per­cent­age of GDP. On this yard­stick, Greece doesn’t look too bad be­cause its debt has low rates. It has to find 4 per­cent of GDP to ser­vice its bor­row­ings, less than the 5 per­cent that Italy and Por­tu­gal have to pay, ac­cord­ing to the Lon­don School of Eco­nom­ics’ Paul De Grauwe.

When look­ing at the health of a com­pany, it is wise to ex­am­ine its bal­ance sheet, cash flow and profit. Sim­i­larly, with a gov­ern­ment, one should look at its debt, gross fi­nanc­ing needs and in­ter­est pay­ments.

Tak­ing such a holis­tic ap­proach, Greece needs some debt re­lief. But the eu­ro­zone can prob­a­bly achieve this by stretch­ing out still fur­ther the amount of time Athens has to re­pay its loans. It may not be nec­es­sary there­fore to cut their face value.

IMF Man­ag­ing Di­rec­tor Chris­tine La­garde sits in be­tween eu­ro­zone fi­nance min­is­ters at a Eurogroup ear­lier this year.

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