Greek rescue bizarrely increases its debts
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.
TOTTING IT ALL UP
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.