A GREEK tragedy is typically composed of three acts, with the first dedicated to setting the scene. For present-day Greece, the imposition of “voluntary” losses on the country’s private creditors represents just the end of the beginning, the real tragedy has still to unfold.
The “voluntary” arrangement with creditors might appear to have been a big success. The volume of Greece’s foreign debt has been reduced by more than €100 billion and its European partners have provided €130bn in new loans. As a result, Greece has avoided generalised bank failures, and has been able to pay its public employees.
However, Greece’s debt ratio remains at 120 per cent of last year’s GDP. With a projected drop in GDP of 7 per cent this year and a sustained deficit, the debt ratio would exceed 130 per cent before stabilising at 120 per cent in 2020.
But even this reduced level is not sustainable. With its population set to contract by 0.5 per cent annually over the next 30 years, even if per capita income in Greece were to rise at the German rate of 1.5 per cent per year, the debt would be difficult to service, requiring a healthy budget surplus just to keep the debt burden stable.
So why are the European Union and the International Monetary Fund celebrating the recent agreement? Simply put, their primary objective was to minimise the repercussions a Greek default would have on the international financial system. Greece itself, frankly, was not their priority.
Given the reaction in financial markets, they have succeeded. The delay in reaching an agreement enabled most private creditors to escape the consequences of their reckless lending to Greece – roughly half of Greece’s external debt migrated from the private sector to official institutions.
But the group of lenders that the EU and the IMF wanted to help the most – the banks – only partly reduced their exposure. Between May 2010 and September 2011, the value of Greek sovereign debt held by French banks dropped by €4.6bn (39 per cent), German banks by €2.9bn (31 per cent) and Italian banks by €530bn (30 per cent). But in part, this drop reflects the reduction in market value of the existing liabilities.
And while private-sector losses have been minimised, at what price? Had Greece defaulted on its debt in 2010, imposing the same “haircut” on private creditors as it has imposed now, it would have reduced the debt-to-GDP ratio to 80 per cent. That could have spared the Greeks from a 7 per cent decline in GDP and a rise in unemployment to 22 per cent.
More importantly, a default in 2010 would have left some room for adjustments. Under the current plan, there is none: if the economy does not turn around quickly, Greece will need more help.
But where can it go now to find it? Most of the sovereign debt is now held by the official sector, which traditionally does not allow any haircut. The remainder has been reissued under English, not Greek, law, putting it outside of the control of the Greek government and its new collective-action clause, which facilities partial defaults.
Greece has exhausted its ability to share part of the burden with the private sector. Next time, Europe’s taxpayers will be on the hook.
The second act of the tragedy will cast desperate Greeks against angry Europeans. Only at the climax will we know if the effort to delay the inevitable contributed to undermining the idea of Europe for the current generation.
• Luigi Zingales is professor of entrepreneurship and finance at the University of Chicago Booth School of Business.