A Greek tragedy is typically composed of three acts. The first sets the scene. It is only with the second that the plot reaches its climax. For current-day Greece, the imposition of “voluntary” losses on the country’s private creditors represents just the end of the beginning. The real tragedy has still to unfold.
On the face of it, the “voluntary” arrangement with creditors might appear to have been a big success. The volume of Greece’s foreign debt has been reduced by more than 100 billion euros (US$132 billion) and its European partners have provided 130 billion euros in new loans. As a result, Greece has avoided generalized bank failures and it has been able to continue paying its public employees.
However, despite these trumpeted results, the reality is much harsher. Even with the latest deal, Greece’s debt ratio remains at 120 percent of last year’s GDP. With a projected drop in GDP of 7 percent this year and a sustained deficit, the debt ratio would exceed 130 percent before stabilizing at 120 percent in 2020.
However, even this reduced level is not sustainable. With its population set to contract by 0.5 percent annually over the next 30 years, even if per capita income in Greece were to rise at the German rate of 1.5 percent per year, the debt would be difficult to service.
Assuming that Greece could borrow at a real interest rate of only 3 percent (the current level is 17 percent), the government would need to run an annual 2.6 percent of GDP primary budget surplus (the fiscal balance minus debt-service costs) for the next 30 years, just to keep the debt burden stable.
To put that task in perspective, in the last 25 years, Greece ran an average primary deficit of 2 percent per year. To reduce the debt-to-GDP ratio to 70 percent, Greece would have to maintain an average primary surplus of 4 percent for the next 30 years, a level that it has temporarily achieved in only four of the last 25 years.
If the situation is so dramatic, why are the EU and IMF celebrating the recent agreement? Simply put, these institutions’ primary objective was to minimize the repercussions that a Greek default would have on the international financial system. Greece, frankly, was not their priority.
Given the reaction in financial markets, they have succeeded. The delay in reaching an agreement enabled most private creditors to escape the consequences of their reckless lending to Greece. About half of Greece’s external debt migrated from the private sector to official institutions.
However, the group of lenders that the EU and the IMF wanted to help the most — the banks — only partly reduced their exposure. Between May 2010 and September last year, the value of Greek sovereign debt held by French banks dropped by 4.6 billion euros (39 percent), while German banks reduced their holdings by 2.9 billion euros (31 percent) and Italian banks by 530 million euros (30 percent). In part, this drop reflects the reduction in market value of the existing liabilities. Thus, on average, banks have sold very little.
However, while private-sector losses have been minimized, what has the price been? Had Greece defaulted on its debt in 2010, imposing the same “haircut” on private creditors as it has imposed now, it would have reduced the debt-to-GDP ratio to a more manageable 80 percent. That would have been painful, but it could have spared the Greeks from a 7 percent decline in GDP and a rise in unemployment to 22 percent (including an increase in youth unemployment to a whopping 48 percent).
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