Tuesday was all about debt relief for Greece.
To recap, a new "secret" report [7] on Greek debt sustainability leaked to Reuters on Tuesday morning suggested that the Fund believes the country requires "debt relief measures that go far beyond what Europe has been willing to consider so far." The report goes on to paint a rather bleak picture of Greece’s economic and financial situation:
Greece’s public debt has become highly unsustainable. This is due to the easing of policies during the last year, with the recent deterioration in the domestic macroeconomic and financial environment because of the closure of the banking system adding significantly to the adverse dynamics. The financing need through end-2018 is now estimated at Euro 85 billion and debt is expected to peak at close to 200 percent of GDP in the next two years. Debt would peak at close to 200 percent of GDP in the next two years. This contrasts with earlier projections that the peak in debt—at 177 percent of GDP in 2014—is already behind us. By 2022, debt is now projected to be at 170 percent of GDP, compared to an estimate of 142 percent of GDP projected in our published DSA. Borrowing at anything but AAA rates in the near term will bring about an unsustainable debt dynamic for the next several decades. Other options include explicit annual transfers to the Greek budget or deep upfront haircuts. The choice between the various options is for Greece and its European partners to decide.
The EMU leaders and finance ministers who gathered in Brussels last weekend were supposedly made aware of the IMF’s assessment on Sunday or early Monday, and indeed the timing of the report looks to be rather convenient, much like the timing of the original IMF Greek debt assessment which leaked just three days before the referendum and may well have bolstered the case for the “no” vote. It would appear that the US may be pulling the strings behind the scenes in order to pressure Germany on writedowns for Greece’s debt burden, or, as The Telegraph's Ambrose Evans-Pritchard put it [8], "the backdrop to this sudden shift in position is almost certainly political [and] follows an intense push for debt relief over recent days by the US Treasury, the dominant voice on the IMF Board in Washington."
The report was billed by FT and others as the first suggestion [9] that Christine Lagarde might take her ball and go home in the absence of debt relief for the Greeks, something the Fund has threatened in the past.
On Wednesday, the European Commission published their own assessment of Greece’s debt sustainability which reveals (surprise!) that some manner of debt relief will like be necessary going forward. Here are the highlights from the document (dated July 10):
The economic and financial situation in Greece has strongly deteriorated following policy uncertainty, shortfall in government revenues, the authorities' decisions that made the bank holidays and the imposition of capital controls necessary, and the missed payments to the IMF and Bank of Greece.
The failure to complete the review, the missed debt service payments, the expiration of the EFSF programme and the introduction of capital controls have created new circumstances which have led to a further strong deterioration in debt sustainability. The following paragraphs present the different assumptions according to a baseline and an adverse scenario and give the respective numbers in these two scenarios:
- Growth estimates have been further revised downwards: preliminary revised projections point to a strong decline in economic activity in 2015. Real GDP growth expectations now range from -2% to -4.0% in 2015, compared with 0.5% in the Spring forecast. 2016 should also see negative growth -0.5% to -1.75% with growth picking up only in the course of 2017, assuming that political stability is restored soon and a gradual relaxation of the administrative measures on the banking sector. Long-term growth is assumed at 1.8% in the base line and at 1.5% in the adverse scenario.
- The expected primary surplus outcomes have been revised downwards. The fiscal programme, which had been on track until the third quarter of 2014, was de-railed in the last quarter of 2014. The weaker implementation of reforms in the second half of 2014 and the turn of the economic cycle led to a primary balance rather than a primary surplus. Moreover, the political uncertainties and the severe policy slippages of the first half of 2015 have led to a strong deterioration of economic growth and hence to weaker primary balance outcomes. Furthermore, the imposition of capital controls and the severe liquidity shortage in the Greek economy now require a further downward revision of the fiscal targets at least for 2015- 2017. It is now expected that primary balance outcomes would decrease substantially. A primary deficit of 0% to 1% is expected in 2015, a primary balance of 1% to 0.5% in 2016 and a primary surplus of 2.25 to 2% in 2017, before moving to 3.5% from 2018 onwards. The expected outcomes have been lowered in view of the developments of the Greek economy.
- Privatisation receipts are likely to be lower than envisage when the last review was completed. The strong deterioration in the banking sector outlook, heightened economic and political uncertainty, more challenging financing conditions for potential investors together with reduced prospects for the privatisation programme result in lower expected privatisation proceeds, though the government intends to proceeds with privatisation projects. We could expect until 2022 EUR 10 bn would materialise in the baseline scenario going down to EUR 4 bn in the adverse scenario (compared to EUR 22 bn before).
- Financing needs for the banking sector have increased considerably. The capital situation of Greek banks is coming under increasing pressure due to worsening asset quality that is related to the significantly weaker macro-economic development, high political uncertainty, the delayed NPL resolution process and the significant adverse impact of capital controls on economic activity and payment culture. In view of this banks will face substantial capital needs. As they will likely have no market access in the near future, an adequate capital backstop as part of a next financial assistance programme is needed. The estimated size of the required capital backstop amounts on a preliminary basis to EUR 25 bn. Further work on 8 the calibration and terms of such capital backstop is currently ongoing among the different institutions.
Based on the developments above, the debt-to-GDP ratio is expected to reach 165% in 2020, 150% in 2022 and 111% in 2030 in the baseline scenario. The respective debt/GDP ratios in the adverse scenario are: 187% in 2020, 176% in 2022 and 142% in 2030..
The high debt to GDP and the gross financing needs resulting from this analysis point to serious concerns regarding the sustainability of Greece's public debt. The concerns could be addressed through a far reaching and credible reform programme, very strong ownership of the Greek authorities for such a programme and, after full restoration of the loans agreements, debt-mitigating measures that would be granted only once the commitments to reform from the Greek authorities has been demonstrated. A very substantial re-profiling, such as a long extension of maturities of existing and new loans, interest deferral, and financing at AAA rates would allow to cater for these concerns from a gross financing requirements perspective, though they would still leave Greece with very high debt-to-GDP levels for an extended period.
So in short, Greece's debt is unsustainable. The IMF knows it, and Europe knows it.
The difference appears to be in how each side believes the situation should be mitigated. The IMF uses language that is absolutely abhorrent to Germany. The idea of "deep upfront haircuts" or perhaps worse "explicit annual transfers to the Greek budget," would not only be politically unpopular in the Bundestag, but would send the "wrong" message to sypathetic debtor states and periphery countries where political parties with ideological parallels to Syriza enjoy strong support.
Nevertheless, something will clearly have to give if Europe expects the third program for Greece to be less blackhole-ish than two bailouts that came before.
So once Tsipras forces Greek lawmakers to legislate away their sovereignty, discussions of "re-profiling" will need to begin. The only question is whether the IMF (and tacitly, the US) will succeed to forcing Germany to "mark it zero [10]."
