Greece is heading for a 3rd bailout that entails eurozone write-downs of its holdings of Greek debt whether Germany, Finland, Austria and the Netherlands like it or not.
In March’s second bailout of Greece, the troika agreed to designate a sustainable debt ratio 120% of GDP by 2020. This number is problematic for two reasons.
First, assumptions for Greek economic growth are much higher than warranted; Greece will never grow enough to reduce the debt to 120% of GDP. If Greece’s economy is merely 10% smaller than projected by 2020, the ratio will be 133%. Recall that all economic forecasts for Greece have been much rosier than reality since the start of the crisis, and you will see that this is a reasonable assumption to make.
Second, the ratio is unrealistic anyway. Spain currently has a debt ratio of 90%, and it’s in a lot of trouble. Italy is both wealthier and more economically developed than Greece, and it is having problems with a 120% ratio. Even if Greece somehow manages to attain this number, it will still be choking on too much debt.
The politicians wish to delay the day of reckoning as long as possible to stay in office, and these are their ideas:
- Reduce interest rates on bilateral loans to Greece to 25 bp saving 5.1% of GDP by 2020.
- Have the ECB return profits on its Greek debt holdings to the eurozone members who will give them to Greece for a savings of 4.6% of GDP.
- Another default on private debt holdings in the guise of a buyback for 2.4% of GDP.
I have omitted one idea from the list. The eurozone also wishes to merely defer interest payments on Greece EFSF loans to 2022 and claims a savings of 16.9% of GDP. This savings is illusory, because the debt is not being saved but rather being pushed past the sustainability date meaning the debt will rise again after meeting the target. This fudge is as cynical as it looks.
Adding numbers one through three, we arrive at a savings of 12.1% of GDP when subtracted from 144% gives us a number of 129.9% of GDP. The bottom line is that the eurozone will have to forgive some of its loans to Greece in order to achieve the magic number, but Greece will still default despite this assistance.
The eurozone will eventually write-down some of the loans. If Greece is going to default anyway, forgiving loans that will never be paid back does not matter. Eventually, the can will be kicked right off the road, but in the meantime the politicians maintain the status quo. A default somewhere in the future is better than a default today.