The lethal deferral of Greek debt restructuring

The point of restructuring debt is to reduce the volume of new loans needed to salvage an insolvent entity. Creditors offer debt relief to get more value back and to extend as little new finance to the insolvent entity as possible.

Remarkably, Greece’s creditors seem unable to appreciate this sound financial principle. Where Greek debt is concerned, a clear pattern has emerged over the past five years. It remains unbroken to this day.

In 2010, Europe and the International Monetary Fund extended loans to the insolvent Greek state equal to 44 per cent of the country’s GDP. The very mention of debt restructuring was considered inadmissible and a cause for ridiculing those of us who dared suggest its inevitability.

In 2012, as the debt-to-GDP ratio skyrocketed, Greece’s private creditors were given a significant 34 per cent haircut. At the same time, however, new loans worth 63 per cent of GDP were added to Greece’s national debt. A few months later, in November, the Eurogroup (comprising eurozone members’ finance ministers) indicated that debt relief would be finalised by December 2014, once the 2012 programme was “successfully” completed and the Greek government’s budget had attained a primary surplus (which excludes interest payments).

In 2015, however, with the primary surplus achieved, Greece’s creditors refused even to discuss debt relief. For five months, negotiations remained at an impasse, culminating in the July 5 referendum in Greece, in which voters overwhelmingly rejected further austerity, and the Greek government’s subsequent surrender, formalised in the July 12 Euro Summit agreement. That agreement, which is now the blueprint for Greece’s relationship with the eurozone, perpetuates the five-year-long pattern of placing debt restructuring at the end of a sorry sequence of fiscal tightening, economic contraction, and programme failure.

Indeed, the sequence of the new “bailout” envisaged in the July 12 agreement predictably begins with the adoption of harsh tax measures and medium-term fiscal targets equivalent to another bout of stringent austerity. Then comes a mid-summer negotiation of another large loan, equivalent to 48 per cent of GDP (the debt-to-GDP ratio is already above 180 per cent). Finally, in November, at the earliest, and after the first review of the new programme is completed, “the Eurogroup stands ready to consider, if necessary, possible additional measures… aiming at ensuring that gross financing needs remain at a sustainable level.”

During the negotiations to which I was a party, from January 25 to July 5, I repeatedly suggested to our creditors a series of smart debt swaps. The aim was to minimise the amount of new funding required from the European Stability Mechanism and the IMF to refinance Greek debt, and to ensure that Greece would become eligible within 2015 for the European Central Bank’s asset-purchase programme (quantitative easing), effectively restoring Greece’s access to capital markets. We estimated that no more than 30 billion euros ($33 billion, or 17 per cent of GDP) of new, ESM-sourced financing would be required, none of which would be needed for the Greek state’s primary budget.

Our proposals were not rejected. Although we had it on good authority that they were technically rigorous and legally sound, they simply were never discussed. The political will of the Eurogroup was to ignore our proposals, let the negotiations fail, impose an indefinite bank holiday, and force the Greek government to acquiesce on everything — including a massive new loan that is almost triple the size we had proposed. Once again, Greece’s creditors put the cart before the horse, by insisting that the new loan be agreed before any discussion of debt relief. As a result, the new loan deemed necessary grew inexorably, as in 2010 and 2012.

Unsustainable debt is, sooner or later, written down. But the precise timing and nature of that write-down makes an enormous difference for a country’s economic prospects. And Greece is in the throes of a humanitarian crisis today because the inevitable restructuring of its debt has been used as an excuse for postponing that restructuring ad infinitum. As a high-ranking European Commission official once asked me: “Your debt will be cut come hell or high water, so why are you expending precious political capital to insist that we deliver the restructuring now?”

The answer ought to have been obvious. An ex ante debt restructuring that reduces the size of any new loans and renders the debt sustainable before any reforms are implemented stands a good chance of crowding in investment, stabilising incomes and setting the stage for recovery. In sharp contrast, a debt write-down like Greece’s in 2012, which resulted from a programme’s failure, only contributes to maintaining the downward spiral.

Why do Greece’s creditors refuse to move on debt restructuring before any new loans are negotiated? And why do they prefer a much larger new loan package than necessary?

The answers to these questions cannot be found by discussing sound finance, public or private, for they reside firmly in the realm of power politics. Debt is creditor power; and, as Greece has learned the hard way, unsustainable debt turns the creditor into Leviathan. Life under it is becoming nasty, brutish and, for many of my compatriots, short.

The writer, a former finance minister of Greece, is a Member of Parliament for Syriza and professor of economics at the University of Athens. ©Project Syndicate, 2015. www.project-syndicate.org