Analysis: EU has good grounds to delay Greek debt crunch

PARIS Mon May 16, 2011 2:15am EDT

People walk past the Bank of Greece in Athens May 9, 2011. REUTERS/Yiorgos Karahalis

People walk past the Bank of Greece in Athens May 9, 2011.

Credit: Reuters/Yiorgos Karahalis

PARIS (Reuters) - Never do today what you can put off until tomorrow.

Many in the financial markets and media are accusing the European Union authorities of doing just that in leaving the gushing wound of Greece's sovereign debt exposed, a year after it became the first euro zone country to receive a bailout.

Financial markets have concluded that Greece will never be able to repay its 327 billion euro ($465 billion) debt pile -- already nearly 150 percent of its economic output. They are pricing in a debt restructuring within a year or so despite vehement denials from Athens, Brussels and Frankfurt.

The cost of insuring Greek debt against default has soared, and two-year government bond yields hit a stunning 27 percent last week -- three times the rate on equivalent Ukrainian or Nigerian government paper.

"The policy response continues to be ad hoc, behind the curve," RBS chief European economist Jacques Cailloux said.

But it's worth considering four solid economic reasons -- and a more flimsy political one -- for postponing what may be an inevitable write-down, even if that means giving Athens more loans on top of the 110 billion euros committed so far.

First and foremost, Greece is in no position to cope with a default because it does not have a primary budget surplus before interest payments and its economy is still deep in recession.

It could not pay its bills without credit, from which it would be shut out for years.

The impact on Greek banks and pension funds, which are major holders of government bonds, and hence on businesses and the wider economy, would be devastating. That could set off a social upheaval in a European Union member state.

"They have to be at a primary balance before they default," said William Cline, a senior fellow at the Peterson Institute for International Economics and a specialist on the 1980s Latin American debt crisis.

"It is in their own long-term interests to stick to what the current plan is, be more aggressive than what that plan calls for and get a firmer commitment beyond 2013 for continued support from European neighbors."

Given a couple more years to shrink bureaucracy, rein in public spending, tighten the tax system, privatize state assets and revive growth, an orderly restructuring might wreak less damage.

Second, other European banks, including the European Central Bank, need time to strengthen their capital positions and reduce their exposure before taking losses on Greek holdings.

Commercial banks across Europe are undergoing stress tests and recapitalization to meet more demanding reserve requirements imposed in the wake of the global financial crisis.

A Greek restructuring now would reverse that recovery process and could set off a chain reaction of consequences.

By the end of 2013, according to EU calculations, official lenders -- euro zone governments, the IMF and the ECB -- will hold more than half of Greece's foreign debt. Only the IMF loans are senior to privately held bonds.

A third reason for delaying and seeking any alternative to restructuring is the potential reputational damage for the entire euro area.

Whether officials dress a Greek restructuring up as a "reprofiling," "rescheduling," or "voluntary bond exchange," it would be widely understood as a default.

That would immediately put all other peripheral euro zone countries in the firing line including Spain, the bloc's fourth largest economy, which has implemented structural reforms and budget cuts to stay out of the danger zone.

"The best way to avoid having to save Spain is by saving Greece," said a senior European industrialist with close government ties, who spoke on condition of anonymity.

"If you don't save Greece, you will have to save Portugal and Spain."

A fourth reason is that if Greece defaulted, international lenders would lose the leverage which the EU/IMF program gives them over its fiscal and economic reforms.

Despite a revenue shortfall due to the economic contraction and chronic tax evasion, Athens achieved a giant 7 percentage point fiscal adjustment in the first year of its bailout.

The EU has an interest in keeping the Greeks on that path and easing the pain by stretching out maturities and further reducing the interest rate on official loans. It may be able to increase the incentive for reform by offering more aid in return for some form of collateral from privatized state assets.

Now for the flimsy political reason. For politicians, the best time to tell voters that some of the billions they lent Greece will never be repaid is always after the next election.

Germany and France are the two biggest lenders. France holds presidential and parliament elections in mid-2012 and the next German general election is due in September 2013.

That falls just after a permanent euro zone rescue fund is due to click in with private investors potentially sharing liability for all new sovereign debt issued.

No wonder German leaders have made clear that any compulsory debt restructuring before late 2013 is out of the question.

(Editing by Ruth Pitchford)

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Comments (1)
breezinthru wrote:
It might make sense to give banks a little more time to brace for a default. None of the other reasons make any sense at all.

In the other instances, more time will not change the outcome or lessen the severity of the consequences. Greece does not have a viable structure for taxing its citizens and that is only one of its structural deficiencies. Greece is a lost cause and every sophisticated investor in the world knows that. It doesn’t matter whether European politicians want to admit it in 2011 or not.

Particularly nonsensical is the reasoning that “if you don’t save Greece, you will have to save Spain and Portugal”. Spain and Portugal at least have governments that function. They simply spend more than they take in and their citizens are victims of the international banking systems failures.

If financial risk takers (banks and investors) are to be protected from losses they should have incurred, then the government and citizens who bear massive losses on behalf of the banks.

Are the people of Spain and Portugal willing to accept a horrible drop in their standard of living? If not, there will be social upheaval. Waiting until after the elections will not change that nor will it guarantee that the recently elected officials will remain in power.

May 16, 2011 7:00am EDT  --  Report as abuse
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