Squaring the debt circle
Athens has struggled to get its euro zone creditors to talk about debt relief. That is because it is not the most urgent issue facing Greece. A short-term cash crunch could trigger bankruptcy in the next few weeks. But if the negotiators resolve the immediate crisis – and the omens don’t look good – debt relief should come onto the table.
The debt, which was restructured in 2012, is huge – 313 billion euros or 175 percent of its gross domestic product. But the bulk, about 184 billion euros, is now owed to euro zone governments and pays low interest. What’s more, Greece doesn’t have to start repaying it until 2020 and then has over 30 years to finish the job. The present value of this debt, what it is worth today, is therefore much lower than its official face value.
This isn’t the full story. Greece has four other sources of borrowing: 27 billion euros owed to the European Central Bank; 20 billion euros owed to the International Monetary Fund; debt owed to private investors; and short-term treasury bills.
The private debt isn’t an immediate problem because most of it has also been rescheduled to stretch out over a long period of time. Nor are the treasury bills, as Athens is still able to roll them over as they come due.
However, the ECB and IMF debt is problematic because most of it comes due in the next five years. Indeed, there is a crunch in the next few months, with over 10 billion euros of repayments by the end of September.
Moreover, IMF and ECB debt cannot be rescheduled without breaching rules and treaties. This is why the focus of the current talks is about lending Greece more money so that it can meet these obligations.
Both Greece and its creditors agree that solving this issue is the most pressing need. But they disagree over what strings should be attached to the provision of more loans. And that means there is now a serious risk that Greece will go bust.
If that scenario is avoided, the issue of longer-term debt relief will come onto the table. Not only does Greece want the renegotiation, the IMF thinks it is necessary to make the country’s debt sustainable.
The euro zone will also be under pressure to provide yet more loans to Athens because the money left in the current bailout programme won’t be sufficient to cover all the repayments due to the ECB and IMF. What’s more, the country has other needs such as paying off overdue bills to suppliers, recapitalising the country’s banks, and repaying the loans it has forcibly extracted from local authorities.
Since the euro zone won’t agree to a writedown of its loans, the obvious solution is to give Athens an even longer holiday before it needs to start repaying this debt and stretch out the period which it has to finish doing so. In this scenario, the present value of the debt would shrink again.
Some observers complain that such a move would do nothing to cut the headline size of Greece’s debt. Although this wouldn’t matter if everybody was rational and focussed on its present value, it might still undermine confidence and so prevent a proper economic recovery.
This is where some financial engineering may be useful. The Greek government has proposed splitting most of the euro zone debt into two parts. One would carry a higher interest rate. The other wouldn’t pay interest at all. Athens then wants this “zero coupon” debt to be gradually written off.
While the euro zone won’t accept the writeoff part of this idea, the debt-splitting scheme could be modified to make it workable. The key insight is that the zero coupon debt will have a much lower present value than its face value. If Greece could find some organisations to take on this liability for a payment equivalent to its present value, it would cut substantially the face value of its debt.
Companies and infrastructure project managers might be interested. They would be essentially receiving long-term loans, which they would repay in one chunk with all the interest rolled up. That’s the sort of funding Europe’s economy could do with, as it needs to boost investment.
The twist is that the companies or infrastructure project managers would receive the upfront cash from Greece – which would have to borrow the money from new lenders – but repay the loans to Athens’ creditors. They would have to agree to a change in the counterparty but they wouldn’t have to write off any loans.
Such a scheme could square Greece’s demand for lower headline debt with the unwillingness of euro zone governments to acknowledge to their taxpayers that they had lost money on lending to Athens.
Some creditor countries will, of course, ask why they should offer yet more help to Greece. The answer is partly that the collapse of a country so close to home is not in their interest.
But it is also ethical. Other euro zone countries prevented Greece defaulting on its debts at the start of the crisis because they were afraid that doing so would bankrupt their own banks, which had lent Athens most of the money. They, therefore, bear some of the blame for Greece’s predicament and some of the responsibility for sorting it out.