Greece may not need debt haircut
How unsustainable are Greece's borrowings? This question has moved centre-stage after the euro zone agreed on Aug. 14 to lend Athens up to 86 billion euros in a new bailout programme. The euro zone 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 euro zone gives Athens relief on its existing borrowings. The snag is several euro zone countries, including Germany, are reluctant to cut the debt burden.
This isn't something that ought to scupper the deal. The euro zone 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. The traditional approach, looking at debt-to-GDP ratios, is not suitable for Greece because its borrowings are mostly on concessionary terms. The euro zone loans already have long grace and repayment periods, as well as extremely low interest rates. A crude debt-to-GDP ratio - which, in Greece's case, is expected by both the euro zone 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' debt - what its total future debt payments are worth in today's money. The European Stability Mechanism, the euro zone'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 euro zone 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.