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An end to Greece's agony

By: The Economist

Posted: 11/13/2012 1:00 AM | Comments: 0

A general strike, protesters on the streets, parliamentary battles over the austerity measures needed to unlock rescue funds and a sinking economy with an ever-bigger debt burden. The situation in Athens this week is grimly familiar, and not only because Greece has had so many similar weeks during the past couple of years.

There also are eerie echoes of the developing-country debt crises of the 1980s and 1990s. The experience of dozens of debt-ridden countries in Latin America and Africa holds lessons Greece's rescuers ought to heed.

For years the International Monetary Fund and rich-world governments tried to help them with short-term rescue loans. The most indebted started to recover, however, only when their debts, including those owed to official creditors, were slashed. In Europe, Poland also provides a precedent: Its economy took off in the 1990s after it too was given a break by its creditors.

Greece is in the same boat. Now that the country's Parliament passed its 2013 budget on Nov. 11, a fresh infusion of rescue funds will stave off imminent catastrophe. Greece's economy won't recover, however, until it has more debt relief. That should involve, broadly, a two-part process: First, agree on a plan to reduce debt if certain targets are met, then cut the debt in stages during the coming decade.

The starting point is that Greece is still bust. Earlier this year private-sector bondholders reduced their nominal claims by more than 50 per cent, but that deal did not include the hefty holdings of Greek bonds at the European Central Bank, and it was sweetened with funds borrowed from official rescuers.

For two years those rescuers had pretended Greece was solvent and provided official loans to pay off bondholders in full. As a result more than 70 per cent of the debts are now owed to "official" creditors -- European governments and the IMF.

Their chances of repayment are sinking with Greece's economy. Government forecasts now suggest the country's debt will exceed 190 per cent of GDP in 2014, some 30 percentage points higher than the IMF predicted six months ago. This debt burden cannot fall to a remotely sustainable level without additional relief.

In private, many Europeans admit this. In public, they deny it categorically. Germany's government is now willing to grant the Greeks more time to implement their austerity, but it will not even discuss any forgiveness of official loans.

Politically this is understandable. Germany worries that any debt relief will reduce Greece's incentive to undertake reforms. It also would enrage German voters, who might then punish Chancellor Angela Merkel's government in the general election next autumn.

Economically, it is a disaster. As long as everybody knows Greece cannot repay its debts, the country will remain shut out of private bond markets, and uncertainty about how those unpayable debts eventually will be resolved will deter investment. It will slow the privatization of state assets, which is central to Greece's turnaround strategy.

That's why Greece needs another debt-reduction deal. Its official creditors, particularly the eurozone's governments and the ECB, should set out a plan for reducing the country's debt burden while sharpening Greece's incentive to reinvigorate reforms.

One guide could be the "HIPC" initiative -- the acronym stands for "Heavily Indebted Poor Countries" -- the 1996 plan whereby lenders agreed to reduce the debts of the most compromised countries if they implemented reforms to reduce poverty. Another could be newly democratic Poland, which had run up huge debts under its communist rulers. In 1991, sympathetic creditors agreed to cut its debt burden if reforms were undertaken.

A bargain with Greece's official creditors could follow the same principle. A deal would be made now: If Greece sticks to its reforms, its official debts will be reduced, in stages, to a level -- say, 120 per cent of GDP by 2020 -- at which the stock is manageable, the burden is bearable and the repayment schedule is feasible.

The reduction could come through cutting interest rates and pushing out maturities, perhaps to as much as 50 years. That way Merkel can explain to voters that the principal is being paid in full. The ECB, which holds Greece's remaining unrestructured private bonds, should act fastest, accepting terms similar to those imposed on private bondholders.

There are complications. The IMF sold gold to finance its share of HIPC debt relief. Since Greece, even now, is far richer than most of the IMF's members, Europe's creditor countries should shoulder the fund's share of Greek debt reduction.

Greece might flunk its reforms or its budget numbers, but the impact of laying out a credible path to debt sustainability could be powerful. Greeks could start to believe they have a way out of the crisis, and investors could put money into the country with more certainty. It could create a positive circle of confidence and growth.

Without it, Greece's prospects are dire.

Republished from the Winnipeg Free Press print edition November 13, 2012 A7

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