Greek rescue bizarrely increases its debts

July 25, 2011

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Listen to the politicians and one might think that Greece’s debts will fall as a result of last week’s provisional rescue by euro zone leaders and private-sector creditors. In fact, they go up. Athens’ borrowings will increase by 31 billion euros under the rescue scheme, according to an analysis by Reuters Breakingviews. This increase, equivalent to 14 percent of GDP, will push the country’s estimated peak debt/GDP ratio next year to 179 percent.

This bizarre result comes because of the way the different elements of the fearfully complex rescue plan interact. Greece will need to borrow extra funds to enhance the creditworthiness of the new bonds it will provide the private sector. It will also need to inject capital into its own banks. These extra borrowings amount to 55 billion euros and will more than outweigh the reduction in Greece’s debts that comes as a result of haircuts to be agreed by private-sector creditors and a planned buyback of debt at a discount to its face value.

The Breakingviews analysis is at variance with comments made by Nicolas Sarkozy, France’s president. He said after the July 21 summit of euro zone leaders that Greece’s debts would fall by 24 percentage points of GDP.  This was because he ignored the costs of “credit enhancement” and bank recapitalisation. He also included in the debt reduction 12 percentage points of GDP coming from the fact that Athens will be paying low interest rates on its official loans. While this will definitely improve the country’s debt sustainability, the benefit (under Sarkozy’s maths) will be spread over 10 years.


The euro zone leaders agreed to provide 109 billion euros in extra funds to Greece. This money will be supplied by the European Financial Stability Facility (EFSF), the euro zone’s bailout fund.

At the same time, private-sector creditors, under the auspices of the Institute of International Finance (IIF), plan to contribute a gross 54 billion euros to Greece’s funding needs by mid-2014 and a further 81 billion euros between mid-2014 and end-2020 –- or 135 billion in total. This contribution will come by swapping old bonds for new Greek bonds, or by rolling over old bonds into new bonds when they mature.

The IIF has proposed four “bond swap/rollover” options, two of which would require creditors to take an immediate 20 percent haircut on the value of their bonds. The other options don’t require haircuts but pay lower interest rates.

All this might seem extremely attractive for Greece if it wasn’t for the fine print of the IIF scheme. This requires Greece to provide collateral to partly guarantee the new loans, in a so-called “credit enhancement”. The mechanism for doing this isn’t the same for all the options. But, to guarantee the new 30-year bonds, Athens would purchase 30-year zero-coupon AAA-rated bonds. A zero-coupon bond is one that pays no interest. With such collateral, the creditors would be sure that they would at least get their money back at the end of the period — even if Greece couldn’t pay the interest on the loans.

Zero-coupon bonds are not as expensive to buy as normal bonds. But these 30 year instruments will still cost just over 30 percent of their face value. Greece will therefore need to find 42 billion euros to finance credit enhancements for the 135 billion euros of bonds covered in the IIF’s scheme, according to a paper presented to the euro zone leaders at their summit. Of this, 35 billion would need to be found before mid-2014. The EFSF will lend Greece that money and that is the main reason why Athens’ debts will rise rather than fall.

The remaining 7 billion euros of the 42 billion euros credit enhancement is expected to be required after mid-2014 because some of the debt that would be rolled over into new bonds wouldn’t come due until then. Greece is expected to find that cash itself.

In addition, Greece’s debts will increase because it will have to recapitalise its banks, which have large holdings of their own government’s bonds. The paper presented to the euro zone leaders earmarked 20 billion euros for this purpose. Greece will borrow this money from the EFSF too.


Two parts of the programme will genuinely cut Greece’s debts. The first is the bond swap/rollover mentioned above. The IIF assumes that half of the creditors taking part will choose an option requiring a 20 percent haircut and the rest will go for no haircut. If 135 billion euros of old debt is restructured in this way, Athens’ debt will fall by 13.5 billion euros.

But not all of this will happen immediately — in the same way that not all the cost of credit enhancement will fall due immediately. If one assumes that the debt reduction works to the same timetable as the credit enhancement, this part of the programme would cut Greece’s borrowing by 11.25 billion euros by mid-2014.

The other part of the programme that would cut Athens’ debts is a planned bond buyback. The paper presented to leaders earmarked 20 billion euros for this purpose. It assumed that Greece would be able to buy back debt in the market at 61.4 percent of face value. That would be a premium of 9.54 cents to its market value. With these assumptions, Greece would be able to buy bonds with a face value of 32.6 billion euros. Although it would have to borrow the 20 billion euros from the EFSF, its debts would decline by 12.6 billion euros.

This buyback scheme has also been pushed by the IIF, which argues that a premium to market prices would be required to persuade bondholders to part with their paper. It also believes that this buyback is most likely to appeal to holders of very long-dated Greek bonds, which will not be involved in the “bond swap” and which trade at a particularly deep discount to their face value.


To calculate the net effect of all this on Greece’s debt, it is necessary to add the 35 billion euro cost of the credit enhancement and the 20 billion euros for bank recapitalisation and then subtract the 11.25 billion benefit from the bond swap/rollover and the 12.6 billion reduction from the buyback. This sum comes to 31 billion euros.

The IMF had already earmarked 16 billion euros for bank recapitalisation in its review of Greece earlier this month. That means only 15 billion euros of Athens’ debt increase is unanticipated. The IMF also forecast that the country’s debt/GDP ratio would peak next year at 172 percent of GDP. To calculate a new debt/GDP ratio, therefore, it is only necessary to add the unanticipated extra debt. That is what is done in the Breakingviews analysis to produce a new figure of 179 percent.

It could be argued that this calculation ignores the fact that the 55 billion euros pumped into credit enhancement and bank recapitalisation haven’t vanished. They are assets that will continue to sit on the Greek state’s balance sheet. While that is true, the IMF’s convention is to look at gross debt. There’s a good reason for this. Money sunk into the banks as equity can’t be quickly redeployed to pay Athens’ debts. And what about the cash tied up in credit enhancement? That’s an asset that Greece won’t be able to touch for 30 years and won’t pay a cent of interest in the intervening period.


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Hugo – thanks for the analysis on the Greek “rescue” plan. You’ve stripped away the political spin for us. The ‘naked’ rescue plan looks like hell, for Greece, for investors and for the dizzy-headed politicos that put this together and foisted it upon the markets.

When investors fully understand this matter, contagion is going to wreak havoc across Europe, I think.

Posted by NukerDoggie | Report as abusive

“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that “the buck stops here.” Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.” – Sen. Obama March 20, 2006

Posted by DrJJJJ | Report as abusive

Only politicians could increase borrowing by 55 billion Euros and see it as a reduction in debt.

I guess their all stupid, the world around.

Must be the result of too much inbreeding…

Posted by bobw111 | Report as abusive

They knew exactly what they were doing.

Posted by Intriped | Report as abusive

enjoyed this article because it simply states the situation on the ground. However there is a need to get one point cleared up. This is not a Greek rescue deal as it is so affectionatley referred to. It is in fact a rescue of EU banks which are holding Greek bonds. None of the money referred to in the so called Greek rescue deal even goes to Greece. it goes to pay off bond holders. There is no component for investment in the Greek economy. And as any first econ student knows,no investment, no future growth. Under the current scenario Greece will never be able to pay off its debt. Therefore they should just default and get it over with. This is what will set Greece free for returning to growth. After all 300bil is not very much. If Greece defaults on Thursday it will be forgotten on Monday. But the Greek people and the rest of the EU actually will feel relieved that this whole political dog and pony show is over. Better a horrible end than horror with end.

Posted by georgesmiley | Report as abusive

It makes sense to consolidate debt, but simple math dictates if your out-goings exceed your in-comings then you amount debt, unless you can reduce your outs.

The worrying part of all this is the fact that these are governments which are going bust. Don’t they have accountants? The idea of a government is to serve its people, to ensure that what is needed is provided, within reason of course… with a collective of taxes contributed to the government by workers which is decided upon by members of government… That skinks straight away… There goes democracy.

If it happened once, it will happen again and again – where do the bail-outs stop?

I think its time to say, lets start again but not with the system that we have now, as it has failed us. It has made the rich, richer and the poor, poorer.

We need an equality in the financial structure, globally. No more exploitation of developing countries. A global currency, which ‘the elite’ are pushing for, could be beneficial, but it could also make things much, much worse if it isn’t regulated correctly by an independent body.

The placid state of people is perplexing! People are only now waking up to the fact that the banks are the problem. They should be there to serve the public, not to punish them for missing a payment on a mortgage because of unemployment cuts.

This is a spiraling problem which only feeds the elite more wealth and power. In short, if we do not stop this monster, we are all screwed.

So what is the answer?

These are my thoughts…

It could be time to abolish the current monetary system, we are all equal, or should be. If we contribute to society without being paid, would that work? It sounds like something from Star Trek, but imagine if money was removed from the equation.

Remove your fears of this thought, society would change, but for the better.

People, those who choose, could be educated to higher levels. If greed was removed problems would be resolved instantly, technology could be allowed to progress to aid humanity before we destroy ourselves.

We could want for nothing, but dependent on what role you play in society is linked to what you can have. For example, if you are a doctor and serve people, you would have access to almost unlimited benefits. A cleaner would be just as ‘well off’ as a bank manager of today. That system would empower people to do better, at any time as it wouldn’t be limited to age.

A social structure would still exist and would work on the principle of material possessions. It’s not like we would all be driving Ferrari’s, as they would not be deemed environmentally aware, therefore limited to a time period which you could have one, but if you wanted to you could have that car you wanted, then swap it with no cost involved, no insurance, no need for ownership. No mortgage payments, no electricity bills, no council tax – Nothing!

There would need to be a tagging system so that people can be tracked, for the purposes of identifying what you do, your privileges etc, for additional benefits out of your reach, you could trade in items/benefits to upgrade, but since there is no limit, the easiest option is to invest in yourself.

If such a system was enabled, it would make us realise that possessions do not make us who we are and that living a life based on personal development and experiences is more rewarding than this rat race we have today.

The knock-on effects would be profound, we could feed the world, provide fresh drinking water to everyone who needs it. Pharmaceutical companies would be forced to create medicines that benefit people, rather than hinder…

I’m sure there are many issues in the plan, but they are probably smaller than the problems we have now!

What a complex web we have woven…

Posted by chris_J | Report as abusive

Once again, the guilty walk away scott free and the nation’s people are forced to take on even more debt than that which created the crisis! The entire episode is a method to force the sale of public owned items to private corporations at fire-sale prices and nothing more. Greece should have defaulted. They would have recovered in two years. Now, it will be 10 to 15 years before the private economy can even catch up where it is now. Shame on the bankers and finance people for this criminal act.

Posted by robert1234 | Report as abusive

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Posted by Ο ΟΟΣΑ Ξεβρακώνει Παπανδρέου και Ευρω-Συμμορία » Ενιαίο Παλλαϊκό Μέτωπο (Ε.Πα.Μ.) | Report as abusive

Here a question: Isn’t bank recapitalisation necessary in any case – in Euro or in Drachma? If so, then just because it has been decided along the other actions of the new packet it does not make it an integral part of the calculation in terms of judging about alternative possibilities. If not, then can someone give an argument why banks would not need to be recapitalized after a (proper) default?

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