The Greek Bail-out Package and the Future Political Risks of Debt Restructuring

Greece’s elected government—and by extension all Greek citizens—face a tremendous moral dilemma which may not have been fully thought out. The IMF/Eurozone bail-out package of EUR 110 bln over three years has been, we learned in Kathimerini yesterday, accompanied by ECB purchases of Greek bonds to a total of EUR 44 bln. The ECB has purchased these bonds primarily from private banks: previous articles have stated that French banks have been at the forefront of Greek bond sellers.

Greece’s debt at the end of 2009 stood at EUR 298 bln, versus a GDP of EUR 237 bln. By the end of 2010, we can assume that total debt under the best case scenario will have risen by at least EUR 36 bln to EUR 331 bln as follows:

·         EUR 6 bln healthcare settlement

·         EUR 10 bln OSE debt assumption

·         EUR 2 bln other public organisations, guaranteed by the government

·         EUR 15 bln government deficit (assumption)

Taking into account a forecast -5% GDP decline (my estimate), Greece’s GDP will be EUR 225 bln, and its debt:GDP ratio will be 147%.

By 2012, when the bail-out package is set to expire, I estimate that in the best case, the public sector debt will have reached EUR 368 bln, or 165% of GDP. My estimate does not specifically include the interest cost of the debt, which I have no way of modeling given the opacity of public statistics on Greece’s debt portfolio.

Assuming the ECB purchases no further Greek bonds, the Eurozone governments, the IMF and the ECB will have purchased a total of EUR 154 bln of Greek sovereign debt, to which they will have senior rights.

This means that 48% of Greece’s total debt in 2012 will be held by the Eurozone, the IMF and the ECB.

And this is the problem: before the bail-out package was agreed, Greece could have defaulted on its debt, which was overwhelmingly held by private sector banks. This would have been painful, but it is a fairly routine affair.

From 2012 and afterwards, 48% of the debt will be held by sovereign partners or multilateral institutions. Will Greece really be able to restructure debt or impose a bond “haircut” on Germany or France?

What happens the day after that occurs?

It is clear to me that Greece is caught in a debt spiral. The absence of any decisive action by the government on issues such as OSE or even the healthcare debt settlement are indicative of the problem.

Minister of Infrastructure and Public Transport Dimitris Reppas, for example, yesterday stated that he would not accept layoffs at OSE, the Hellenic Railways Organisation:

Should no solution be found, sources claim that Brussels has even spoken of layoffs in order to reduce workers, although Infrastructure, Transport and Networks Minister Dimitris Reppas stressed yesterday he would not accept layoffs at OSE and ministry sources made it clear that the organization’s chief would not stay in his post if he were to witness OSE employees being laid off.

This is pure political theatre. There will not be a real “solution” to OSE–or any other loss-making Greek governmental organisation–as long as half-measures like this are taken.

On the healthcare settlement, although a minimum 15% haircut on the settlement (amounting to a debt restructuring) is expected, the government never made an attempt to figure out which contracts should be honoured, and which contracts should be investigated for corrupt practice: all contracts were honoured at face value. This rewards the corrupt, while punishing the honest.

This same half-hearted approach is visible all across the government. It is seen in the ridiculous attempt to solve the “cabotage” issue with quantitative restrictions reminiscent of 1970s dirigisme. It is seen in the government’s attempt to extend liquidity to Greece’s banks, and then require them to use that liquidity to buy government bonds, or extend loans to government organisations. It is seen in the incomprehensible decision to prop-up companies in the textiles or fertilizers sector which should have gone bankrupt a long time ago.

Absent bold, radical action to close loss-making government organisations, downsize the public sector, and free the private sector from the absurd tangle of regulations which are largely meaningless in their supposed utility, there will not be an exit from the debt trap we are in. Neither major political party has come forward with a coherent vision or policy programme to address this.

My advice is: prepare for the worse-case scenario to materialise. The clock is ticking. The scale of the problem is clear; the end-date in the best case is late 2012 or early 2013: it may come sooner than we think if the bond yields on recent issues are any guide.