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27 October 2011 By Neil Unmack

Greece’s haircut is looking a bit untidy. Banks have agreed the outlines of a deal to chop 50 percent off the value of their Greek government bonds, clearing the way for further euro zone support. But it still leaves Greece with a bigger debt burden than at the start of the crisis.

While the outlines of Greece’s latest private sector involvement (PSI) debt swap have been struck, much is still up in the air. Banks have agreed a nominal haircut of 50 percent by exchanging their existing bonds for new paper. But they are still negotiating over what they will precisely receive in return. Factors like the maturity and interest rate on any new bonds will determine banks’ actual loss. The sweeter the deal, the more likely creditors will agree to it.

Assume, very generously, that private creditors holding 200 billion euros of bonds sign up for the deal. That’s about 90 percent of Greece’s outstanding private debt, excluding those bonds held by the European Central Bank and short-term treasury bills. A 50 percent haircut would reduce Greece’s total debt by 100 billion euros, to around 256 billion euros.

However, in order to sweeten the deal, Greece will also give bondholders 30 billion euros of risk-free collateral to underpin the value of their new bonds. Greece will have to borrow that amount from Europe’s bailout fund. That lifts its total debt to 286 billion euros, or about 130 percent of GDP – higher than in 2009 when the country’s debt crisis first erupted.

The good news is that the deal forces banks to write down their Greek bonds to more realistic levels. That should mean Greece’s debt woes have less power to traumatise markets. But the agreement is hardly a game-changer. Under this scenario, Greece’s debt would still be 120 percent of GDP in 2020 – and that assumes the country runs an annual primary budget surplus of at least 4 percent of GDP during those years. The potential for political tension is still large: Greeks may tire of austerity; the euro zone may resent having to lend Greece a further 100 billion euros for just the next four years. More restructuring may still be necessary.


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