The improbable Greece plan

By Felix Salmon
February 21, 2012

Greece is now officially a ward of the international community. It has no real independence when it comes to fiscal policy any more, and if everything goes according to plan, it’s not going to have any independence for many, many years to come. Here, for instance, is a little of the official Eurogroup statement:

We therefore invite the Commission to significantly strengthen its Task Force for Greece, in particular through an enhanced and permanent presence on the ground in Greece… The Eurogroup also welcomes the stronger on site-monitoring capacity by the Commission to work in close and continuous cooperation with the Greek government in order to assist the Troika in assessing the conformity of measures that will be taken by the Greek government, thereby ensuring the timely and full implementation of the programme. The Eurogroup also welcomes Greece’s intention to put in place a mechanism that allows better tracing and monitoring of the official borrowing and internally-generated funds destined to service Greece’s debt by, under monitoring of the troika, paying an amount corresponding to the coming quarter’s debt service directly to a segregated account of Greece’s paying agent.

The problem, of course, is that all the observers and “segregated accounts” in the world can’t turn Greece’s economy around when it’s burdened with an overvalued currency and has no ability to implement any kind of stimulus. Quite the opposite: in order to get this deal done, Greece had to find yet another €325 million in “structural expenditure reductions”, and promise a huge amount of front-loaded austerity to boot.

The effect of all this fiscal tightening? Magic growth! A huge amount of heavy lifting, in terms of making the numbers work, is done by the debt sustainability analysis, and specifically the assumptions it makes. Greece is five years into a gruesome recession with the worst effects of austerity yet to hit. But somehow the Eurozone expects that Greece will bounce back to zero real GDP growth in 2013, and positive real GDP growth from 2014 onwards. Here’s the chart:

gdp.tiff

Note that the downside, here, still looks astonishingly optimistic: where’s all this economic growth meant to be coming from, in a country suffering from massive wage deflation? And under this pretty upbeat downside scenario, Greece gets nowhere near the required 120% debt-to-GDP level by 2020: instead, it only gets to 159%. And to make things worse for the Eurozone, the report explicitly says that under the terms of this deal, “any new debt will be junior to all existing debt” — in other words, there’s no way at all that Greece is going to be able to borrow on the private markets for the foreseeable future, so long as this plan is in place.

As in all bankruptcies, the person providing new money gets to call the shots. And it’s pretty clear that the Troika is going to have to continue providing new money long through 2020 and beyond. Under the optimistic scenario, Greece’s financing need doesn’t drop below 7% of GDP through 2020. Under the more pessimistic scenario, it’s 8.8%. And here’s the kicker: all of that money is being lent to Greece at very low interest rates of just 210bp over the risk-free rate. Much higher, and Greece’s debt dynamics get even worse. But of course even with well-below-market interest rates, Greece is still never going to pay that money back.

The cost of this plan is €130 billion right now, and €170 billion over three years, through the end of 2014; it just continues going up from there, with no end in sight. Remember that total Greek GDP, right now, is only about €220 billion and falling.

Oh, and in case you forgot, this whole plan is also contingent on a bunch of things which are outside the Troika’s control, including a successful bond exchange. The terms of the deal, for Greek bondholders, are tough: there’s a nominal haircut of 53.5%, which means that you get 46.5 cents of new debt for every dollar of existing bonds that you hold. The new debt will be a mixture of EFSF obligations and new Greek bonds; the new Greek debt will pay just 3% interest through 2020, and 3.75% until maturity in 2042.

The plan assumes that 95% of bondholders will accept this deal, which seems optimistic to me. Bondholders are by their nature a fractious and contrarian bunch, and Greece is not saying that it’s going to default on holdouts. As a result, bondholders have to guess what might happen if they fail to tender into the exchange: they might get defaulted on and receive nothing; they might get paid out in full; or they might get defaulted on while being offered, for the second time, the same exchange they’re being offered right now. Some of them, especially the ones holding English-law bonds, might well be tempted to hold on to at least some of their bonds, just to see what happens.

More to the point, the plan assumes that Greece’s politicians will stick to what they’ve agreed, and start selling off huge chunks of their country’s patrimony while at the same time imposing enormous budget cuts. Needless to say, there is no indication that Greece’s politicians are willing or able to do this, nor that Greece’s population will put up with such a thing. It could easily all fall apart within months; the chances of it gliding to success and a 120% debt-to-GDP ratio in 2020 have got to be de minimis.

Europe’s politicians know this, of course. But at the very least they’re buying time: this deal might well delay catastrophic capital flight from Greece, and give the Europeans more time to work out how to shore up Portugal if and when that happens. Will they make good use of the time that they’re buying? I hope so. Because once the Greek domino falls, it’s going to take a huge amount of money, statesmanship, and luck to prevent further dominoes from toppling.

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