Greek glass: half-empty or half-full?

At marathon-meeting yesterday, European finance ministers agreed on a new debt deal for Greece, supported by the staff-level agreement of troika of European Commission, European Central Bank (ECB) and the International Monetary Fund (IMF). The main elements of the deal are the following:

• “The adoption by Greece of new instruments to enhance the implementation of the programme, notably by means of correction mechanisms to safeguard the achievement of both fiscal and privatisation targets, and by stronger budgeting and monitoring rules” – yet no further details are available;

• A strengthened segregated account for debt servicing – which echoes the German demand for an escrow account;
• Endorsement of the postponement of a primary surplus target of 4.5% of GDP from 2014 to 2016, which was agreed earlier;
• Bailing-in subordinated bank bond holders during the bank recapitalisation process;
• Buy-back of privately held debt at prices “no higher than those at the close on Friday, 23 November 2012”;
• Reducing the lending rate on bilateral loans from 150 basis points over the 3-month Euribor to 50 basis points (expect by other euro-area countries which are under financial assistance);
• A lowering by 10 bps of the guarantee fee costs paid by Greece on the European Financial Stability Facility (EFSF) loans;
• An extension of the maturities of the bilateral and EFSF loans by 15 years;
• A deferral of interest payments of Greece on EFSF loans by 10 years – yet no further details are available, such as the repayment schedule of these deferred interest payments;
• The full transfer of ECB profits to Greece from the Securities Markets Programme (SMP) starting in 2013 (expect the profit which is allocated to other euro-area countries under financial assistance);
• Further measures will be considered “when Greece reaches an annual primary surplus, as envisaged in the current MoU [Memorandum of Understanding of the financial assistance programme], conditional on full implementation of all conditions contained in the programme”;
• € 43.7 billion loans will be disbursed to Greece by the EFSF in four tranches during the coming months, conditional on the implementation of the MoU;
• The IMF will consider the disbursements of its remaining commitments to Greece “once progress has been made on specifying and delivering on the commitments made today, in particular implementation of the debt buybacks” (see the IMF press release here).

It is expected that these measures will reduce the debt-to-GDP ratio from 144% troika’s baseline to 124% by 2020 and below 110% by 2022.[1]

These measures are sensible and broadly in line with my earlier suggestions, but less ambitious. I proposed that in addition to curtaining the fiscal sovereignty of Greece further and some straightforward debt-reducing measures, such as transferring the ECB profits to Greece, extending the maturities of all official loans, and attempting to buy-back privately-held bonds, the official lending rates should be reduced to zero (and Greece should pay back this interest subsidy beyond 2030) and the notional amount of all official loans should be indexed to Greek GDP. Thereby, the debt ratio would have fallen below 100 percent of GDP by 2020 irrespective of GDP developments till then.

The new Greek deal has two readings.

First, there is a major risk in the success of the buy-back initiative and the 124% debt-ratio target by 2020 is not ambitious enough.

• There is no clarity about the details of the buy-back initiative, apart from the wish to conduct it at prices not higher than the market prices of 23 November 2012 (which were between 25 and 34 cents to the euro for the various maturity new Greek bonds; see the annex of my paper for details about the new Greek bonds). Since the new Greek bonds are under the English law and are safeguarded with a co-financing agreement with EFSF, the incentives for bond holders to sell their holdings at such low prices would likely be low. The IMF conditioned its continued support to Greece on the success of the buy-back initiative, among others.
• Also, the earlier 120 percent of GDP debt target by 2020 has proved to be inadequate for restoring trust and thereby limiting the probability of a Greek euro exit. A reiteration of a similar target is unlikely to help, as I argued here. That could just prolong economic and social misery and the uncertainty about Greek euro membership.

But there is a second reading of deal as well.

• European lenders expressed their strong determination to keep Greece inside the euro area and suggested considering “further measures and assistance” when Greece will reach a primary surplus, conditional on the fulfilment of the financial assistance programme conditions. This could improve market sentiment and thereby support a quick rebound in output, because deep contractions used to be followed by quick recoveries and the Greek GDP has collapsed by almost a quarter.

Which of the two readings will be shared by the private sector? My fear is that the first one will dominate. In that case, as I argued earlier, investment could be deterred further, the gradual capital outflow could continue, economic performance could remain weak, employment could fall further, and the social pressure on the government and the parliament could increase. In the wake of a prolonged contraction, the current coalition government may collapse, leading to domestic political paralysis and the chain of events leading to a euro-exit with disastrous consequences inside and outside Greece.

A perfect implementation and a lot of luck will be needed for turning the sentiment from the first to the second reading.

[1] Note: my own baseline calculation indicated a debt-to-GDP ratio of 146% by 2020, quite close to the troika’s baseline of 144%.