The issue of restructuring of the Greek debt is at the centre of the negotiations about how to resolve the Greek crisis. Since the start of that crisis the Greek sovereign debt has been subjected to several restructuring efforts.
- First, there was an explicit restructuring in 2012 forcing private holders of the debt to accept deep haircuts.
This explicit restructuring had the effect of lowering the Greek sovereign debt by approximately 30% of GDP.
- Second, there were a series of implicit restructurings involving both a lengthening of the maturities and a lowering of the effective interest burden on the Greek sovereign debt.
As a result of these implicit restructurings, the average maturity of the Greek sovereign debt is now approximately 16 years, which is considerably longer than the maturities of the government bonds of the other Eurozone countries.
Resulting reduction of interest rate burden
These implicit restructurings have also reduced the interest burden on the Greek debt, as can be seen from Figure 1, where we compare the effective interest payments of Eurozone governments as a percent of their GDP.
- We observe that since 2011 the interest burden of the Greek government has been cut by almost half to reach 4% of GDP in 2014,1 while the interest burden of the other periphery countries (Ireland, Spain, Italy and Portugal) increased.
Since during this period the debt to GDP ratio of Greece increased significantly, this implies that the effective interest burden as a percent of the Greek government debt declined even more. We show this in Figure 2.
- Since the peak year of 2011 the interest payments as a percent of the Greek government debt declined from more than 6% to 2.2% in 2014.2
As a result of these implicit restructurings the headline debt burden of 180% of GDP in 2015 vastly overstates the effective debt burden. Various estimates based on the net present value of future interest payments and debt repayments suggest that this effective debt burden of the Greek government is less than half of the headline debt burden of 180%.
Figure 1. Interest payments (% of GDP)
Figure 2. Interest payments as % outstanding debt (Greek government)
Greece’s debt situation is better than it looks
From the preceding it follows that the effective debt burden of the Greek government is lower than the debt burden faced by not only the other periphery countries of the Eurozone but also by countries like Belgium and France.
- This leads to the conclusion that the Greek government debt is most probably sustainable provided Greece can start growing again.
Put differently, provided Greece can grow, its government is solvent.
The latter point is important. We show this in Table 1. It presents the effective interest rate on the government debt and the nominal growth rate of GDP. The last column presents the difference between the two. It is well-known that if this difference is positive there is a dynamics that leads to an ever increasing debt to GDP ratio.3
What is striking is that Greece has the lowest effective interest (r) burden on its debt but also the lowest nominal growth of GDP (g). As a result the difference (r – g) achieves the highest value in Greece, producing an unstable dynamics. Thus, more than in the other countries the key to stopping this dynamics is to stimulate nominal growth.
- If Greece can return to a nominal growth (inflation + real growth) of only 2% it can stabilise its (relatively low) effective debt burden.
Austerity is certainly not the way to do it. Greece has been the champion of austerity with a cumulative increase of the discretionary primary surplus of 18% of GDP since 2009 (based on Eurostat). This has been instrumental in producing a cumulative decline of GDP of 25%.4
Table 1. Interest rate and nominal growth (2015)
Source: Eurostat and European Commission, Spring Forecast, 2015.
The logic of the previous analysis is that Greece is solvent provided it can return to relatively low nominal growth rates. Today Greece has no access to the capital markets except if it is willing to pay prohibitive interest rates that would call into question its solvency. As a result, it cannot rollover its debt despite the fact that the debt is sustainable.5 Thus I conclude:
- The Greek government is most likely solvent but has become illiquid.
What are the policy implications of this surprising finding?
- The first one is that creditors must stop imposing austerity programs that assume the debt is still 180% of GDP.
While it may make sense to impose gradually increasing primary budget surpluses of 1% to 3%, when the debt to GDP ratio is 180%, it does not make sense to impose such austerity when the effective debt to GDP ratio is only half that number. When the debt to GDP ratio is 180% a country has to generate primary surpluses for a long time so as to reduce the debt to GDP ratio. When the debt to GDP ratio is only half, the need to reduce it is considerably weakened. As a result, austerity can be relaxed.
Put differently, given the relatively low effective Greek debt burden, all what is needed is a programme that would allow to keep the primary budget balance at its present level (which is close to zero).
Such a programme is likely to generate a higher nominal growth rate of GDP. As we have seen, a nominal growth rate of 2% would be sufficient to stabilise the government debt burden.
- A second implication of the fact that the effective Greek debt burden is sustainable has to do with the European Central Bank.
The ECB follows the Bagehot-principle, which states that the central bank may lend money only to those institutions that are solvent but illiquid. The ECB assumes that the Greek government with a headline government debt of 180% of GDP is not solvent. Therefore it is not willing to involve the Greek government bonds into its OMT- and QE-programmes.
In contrast, the ECB is ready to buy government bonds of other countries in the Eurozone, which have a higher effective debt burden than Greece, both in the context of its OMT- and QE-programmes. The refusal by the ECB to treat Greece the same way as the other member-countries of the Eurozone is erroneous and is based on a misdiagnosis of the nature of the Greek debt.
The misdiagnosis by the ECB matters: An unnecessary banking crisis
This misdiagnosis by the ECB now has dramatic effects on the Greek banking system, and thus on the Greek economy as a whole. The ECB takes the view that the Greek banks which hold Greek sovereign debt are now becoming insolvent themselves, and therefore cannot profit from lender of last resort activities.
- Since the (restructured) Greek government debt is most likely sustainable, the Greek banks should be allowed to use their Greek government bonds as collateral to obtain additional liquidity support.
By refusing this, the ECB has caused an unnecessary banking crisis.
This crisis will deepen the recession, increase unemployment and dramatically deteriorate the Greek government budget, transforming a liquidity crisis into a renewed solvency crisis. In doing so the ECB helps keeping Greece in a bad equilibrium. This may force Greece out of the Eurozone. The ECB would bear a huge responsibility for this outcome.
There is a relatively simple solution to the Greek problem
Accepting that the (restructured) Greek debt is sustainable opens the door to both a softening of the austerity programme and to liquidity support of the Greek banking sector. This solution assumes that creditors accept reality. They must acknowledge that their claims on the Greek government have a significantly lower value than their face value. They should make clear to their citizens that the losses were incurred in the past. Admission of this reality must be the first step to solve the problem of the Greek debt.
I am aware that this solution creates political problems.
- First, politicians prefer to live in a fictional world allowing them to pretend no losses have been made so that they can hide the truth to their own taxpayers.
The solution proposed here demands that these governments come out with the truth.
- Second, in order for this solution to be applied the insatiable desire of some creditor countries to punish the Greek for their misbehaviour must be overcome.
This moral hazard idea looms large over the negotiations. Given that the Greek population has suffered so much and has paid a very high price for past mistakes, it is time to repress these desires to go on punishing a whole nation.
Blanchard, O and D Leigh (2013), "Growth Forecast Errors and Fiscal Multipliers", IMF Working Paper, January.
Darvas, Z (2015), "Greek Choices after the elections", Blog Comment, Bruegel, 23 January.
De Grauwe, P (2011), “Managing a fragile Eurozone”, VoxEU.org, 10 May.
De Grauwe, P and Y Ji (2013), "Panic-driven Austerity in the Eurozone and its Implications", VoxEU.org.
Watt, A (2015), "Is Greek Debt Really Unustainable?", Occasional Paper, Social Europe, January.
1 According to Zsolt Darvas of Bruegel the effective interest burden of the Greek government is even lower than 4%; Darvas has estimated this to be a mere 2.6% of GDP. See Darvas(2015). This is significantly lower than the interest burden of countries such as Belgium, Ireland, Italy, Spain and Portugal.
2 According to Watt (2015) the effective interest burden as a percent of the debt is now lower in Greece than in Germany
3 The formula is: where Dt is the debt to GDP ratio and Bt is the primary budget balance.
4 See Blanchard and Leigh( 2013) and De Grauwe and Ji (2013).
5 There is something circular here. The expectation that the Greek government will be faced with a liquidity problem is self-fulfilling. The Greek government cannot find the liquidity because markets believe it cannot find liquidity. The Greek government is trapped in a bad equilibrium. See De Grauwe (2011).