A good deal for Greece, its creditors, and Europe
Amid all the doom and gloom about Greece in the last few weeks, it is easy to overlook an important piece of good news: the debt exchange offer published by Greece on Friday with endorsement by its main private and official creditors. If implemented, this would be a major achievement and an important step toward overcoming the euro zone crisis, almost regardless of what happens next.
Under the offer, bondholders would receive 15 percent of the face value of their bonds in the form of short-term European Financial Stability Facility (EFSF) bonds, plus a set of new Greek sovereign bonds maturing between 2023 and 2042, with a 31.5 percent face value.
This agreement is a very good deal for Greece. The combination of the cut in face values, lower coupons and (in most cases) longer maturity implies a debt reduction of about 60 percent in present value terms (evaluated at a 5 percent discount rate). Assuming high participation (about €200 billion in bonds), this translates into savings of about €120 billion, or 54 percent of Greece’s 2011 GDP. This is very large. By comparison, the Argentine exchange of January 2005, the previous high-water mark, generated present value of debt relief of only about 29 percent of GDP, because although the per-dollar debt reduction was higher, the volume exchanged was much smaller.
Private creditors are also getting a good deal. Although they are being hit hard, they could have done much worse. You will see claims that the “haircut” suffered by creditors is on the order of 75 percent. These are exaggerated, because they compare the present value of the new bonds with the face value of the old bonds. But in a pre-default debt exchange, creditors never have the right to full immediate repayment. They only have the right to keep their old bonds and expect them to be serviced.
A better way to determine the value of the new bonds is to compare them with the present value of the old bonds, assuming they both are subject to the same default risk. This leads to a haircut of about 65 percent — much less than what creditors would have lost in a disorderly default. And it does not reflect two additional benefits: “GDP warrants” that may deliver extra payments beginning in 2015, depending on the level of Greece’s GDP; and an effective upgrade in creditors’ rights compared with those of the old bonds. The new bonds will be issued under English law, making them harder to restructure again in the future, and their repayments will be linked to repayments to the EFSF.
Finally, the agreement is a good deal for Europe — not because it guarantees a good outcome, but because it takes some really bad outcomes off the table. The risks of the new EU-IMF package for Greece are well-known: It assumes a large and protracted reform effort in an economically depressed country where both politicians and the “troika” are deeply unpopular and social tensions are high and rising. And even if the debt exchange is successful, Greek debt will remain very high. Yet the proposed debt exchange and the program that underlies it differ fundamentally from previous instances of “kicking the can down the road.”
Take the worst-case scenario: Following the debt exchange, the program goes offtrack in just a few months, and Greece is cut off from any further borrowing. This would aggravate Greece’s economic downturn and force it into even more austerity to avoid running a primary deficit. But it would no longer lead to a catastrophe. Assuming high participation in the exchange, Greece would face almost no net debt repayments in 2012 and just €1.25 billion in interest payments on the new bonds in 2013. Hence, it would not need to default, let alone leave the euro. Furthermore, Greece would no longer represent a contagion threat, and with a recapitalized banking system, and little or no remaining government deficit, it could likely manage its crisis on its own — at least until large repayments to official creditors begin to fall due in 2014.
While the new Greek debt exchange would be a good deal, it is not yet a done deal: Greece still needs €70.5 billion in EFSF bills to repay its creditors and recapitalize its domestic banks, two things that depend on the completion of a number of fiscal and structural “prior actions” on a tight timetable. For Greece’s sake and Europe’s, one must hope it will succeed.