Greece Debt Sustainability Analysis

Ahsan HayatFaizan AbbasBushra Saeed

Sakina AliAlmas jaferyNida siddiqui

History• The European debt crisis erupted in the wake of

the Great Recession around late 2009 taking place in a handful of euro zone member states  

• Four euro zone states needed to be rescued by sovereign bailout programs, delivered jointly by the International Monetary Fund and European Commission - with additional support at the technical level by the European Central Bank

• The three organizations representing the bailout creditors, called "the Troika“

• The European Central Bank lowered interest rates and provided cheap loans of more than one trillion euro to maintain money flows between European banks

History

•The ensuing adjustment program negotiated with the "troika" formed by the EU, the ECB, and the IMF imposed strict condition i.e.

•A Significant fiscal adjustment•Structural reforms•Privatization efforts

History• In 1992, members of the European Union signed the Maastricht Treaty,

under which they pledged to limit their deficit spending and debt levels• In early 2000s, some EU member states turned to securitizing future

government revenues to reduce their debts and deficits• This allowed the sovereigns to mask their deficit and debt levels through

a combination of techniques, including inconsistent accounting, off-balance-sheet transactions, and the use of complex currency and credit derivatives structures

• From late 2009 on, after Greece's new elected government stopped masking its true indebtness and budget deficit, fears of sovereign defaults in certain European states developed in the public

• In Greece, high public sector wage and pension commitments were connected to the debt increase

• Concerns intensified in early 2010 leading European nations to implement a series of financial support measures such as the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM)

History• In 2010–12, four out of eighteen euro zone states (Greece,

Ireland, Portugal and Cyprus) had difficulty/inability to repay or refinance their government debt, without the assistance of bailout support from the Troika

• The transfer of bailout funds were performed in tranches through multiple years

• On 6 September 2012, the ECB also calmed financial markets by announcing free unlimited support for all euro zone countries involved in a sovereign state bailout from EFSF/ESM, through some yield lowering Outright Monetary Transactions (OMT)

• In regards of Greece and Cyprus, they both accomplished a partly regain of market access in 2014, and are scheduled to have their bailout program periods ended in March 2016

Total (gross) government debt around the world as a percent of GDP by IMF

Debt profile of euro zone countries

Introduction• Wage reductions in parallel with an increase in

unemployment, skyrocketed from 7.7% in 2008 to a peak of 27.5% by 2013

• Largest ever debt restructuring experienced by a "developed" country in 2012

• It became mainly a public sector affair, with the European Financial Stability Facility (EFSF), the IMF and the ECB now holding almost 80% of Greek debt

• To expiate its debt, Greek society had to continue on an adjustment track that was expected to generate a surplus of 3% by 2015 and of 4.5% by 2016 and 2017

Introduction• The EU accepted its entry in the euro zone, even though it

did not comply with the macro and institutional requirements to join the monetary union

• Germany was able to run its current account surpluses on the back of the deficits of the periphery

• The euro allowed countries in the periphery to borrow, for a while, at rates that were totally disconnected from the real credit risk involved

Public debt, GDP, and public debt-to-GDP ratio Graph based on data from the European Commission

Details of Greece debt sustainability report•Athens will struggle to cut its debt burden

to a target of 120 percent of GDP by 2020•Following are the main points in the 9-

page confidential report, which was completed on February 15 and submitted to euro zone finance ministers:

Details of Greece debt sustainability report• The baseline scenario sees Greece being able

to cut its debt-to-GDP ratio to 129 percent by 2020, but only if the country manages to follow through on all its structural reforms, fiscal obligations and its privatization program.

• A critical concern is that a deeper recession caused by delays with structural reforms and privatization implementation will set the program back as high as 160 percent of GDP in 2020

Details of Greece debt sustainability report• Greece's banks may need as much as 50 billion Euros of extra capital, 10

billion Euros more than previously expected, with various analyses conducted by outside parties pointing to a worse-than-forecast situation

• If Greece is to get its debt level down to 120 percent of GDP by 2020, then it will require additional private sector and official sector support

1. A restructuring of the accrued interest owed on debts that are due to be exchanged as part of the bond swap

2. A reduction in the interest rate payable on loans extended to Greece under its first program in May 2010

3. National euro zone central banks that own Greek debt take part in the debt restructuring in the same way as private creditors

4. The European Central Bank transferring the profit on its holdings of Greek bonds to national euro zone central banks and those funds then being discounted from Greece's debt obligations

Details of Greece debt sustainability report• The debt sustainability analysis also provides the first

confirmation of the offer being made to the private sector to take part in Greece's debt restructuring

• Private sector bondholders will see a 50 percent reduction in the nominal value of their holdings, with 35 cents in every euro converted into 30-year bonds amortizable after 10 years and 15 cents paid upfront in short-term notes

• A coupon of 3 percent would be paid on the bonds from 2012-2020, rising to 3.75 percent from 2021 onwards

• A GDP-linked additional payment would also be made, capped at 1 percent of the outstanding amount of new bonds

• The report assumes a creditor participation rate of 95 percent• The debt trajectory is extremely sensitive to program delays,

suggesting that the program could be accident prone, and calling into question sustainability

Is Greece’s debt really so unsustainable?• First, sovereign states never repay their

debt, they refinance it by issuing new debt• Its debt is largely held by official creditors,

i.e. the European Financial Stability Facility (EFSF), and other euro zone member states

• The debt has a relatively long maturity, which has been extended to 30 years, as part of the conditionality associated with the adjustment program

Is Greece’s debt really so unsustainable?• The sustainability of the debt depends on the dynamics over

time rather than on the overall level.• A high debt-to-GDP ratio can be more sustainable than a lower

one, if the former component is expected to stabilize and fall over time, while the latter continues to grow unabated

• The interest burden on the debt is around 4% of GDP in 2015, lower than countries like Ireland, Portugal or Italy as official creditors have accepted a reduction of the interest rate on their loans to levels comparable to those of the best euro zone borrowers

• Greece is expected to grow by close to 3 per cent this year, faster than the euro zone average

• Greece is expected to improve its primary balance to 4.1 per cent of GDP (up 1.4 per cent from last year), better than Portugal or Italy

Is Greece’s debt really so unsustainable?• Greece’s debt is expected to fall by about 7

percentage points of GDP this year and 11 points in 2016, down to 135 per cent of GDP in 2019, with an overall 40 points reduction in 5 years, more than that required by the fiscal compact

• Although  Greece’s per capita GDP has fallen by about 25 percent, Greece’s average income is still 8 per cent higher than at the start of monetary union

• During the eight years prior to the crisis — between 1999 and 2007 — Greece’s average income increased by 36 per cent, three times the rate of the euro zone, which was clearly unsustainable and helped cause the bursting of the bubble

Assistance Program

• Those who support fail to appreciate the negative effects it would have on financial markets’ confidence in eurozone countries, which has only recently been regained.

• Following the unavoidable debt write-down for Greece in 2012, the heads of state and government of the eurozone declared that it was a one-off event.

• The write-down was due to the special situation that existed in Greece at the time. The leaders’ clear statement, and the decisive action that accompanied it, helped to restore investor confidence.

Debt write-down does not make sense — and neither is it

necessary.

•Calls for a write-down ignore the fact that Greece has achieved a lot in the meantime.

•According to forecasts by the Troika, which consists of the European Central Bank, the International Monetary Fund and the European Commission, Greece’s debts will stabilize in 2014 and decline rapidly afterwards.

•The vicious circle of old debt leading to additional new debt will be broken. The aid that was provided, which is intended to help the country help itself, will enable Greece to succeed in getting its own debts under control.

What must Greece do to return to growth and prosperity

1. Debt sustainability is key. • The decisive factor is not the current debt level

but the sustainability of the country’s debt over time.

• This issue is based on the country’s economic approach in conjunction with the Troika’s assessment of the extent to which the economic outlook for Greece is realistic in terms of also servicing debt that becomes due in the future.

• Debt sustainability is an essential precondition else the country will not be able to repay its loans.

2. Implementation of reforms to foster growth.

• Growth-oriented structural reforms and consolidation of public finances leading to a decline in debt levels.

• Following the economic slump of the last few years, the Troika expects that the Greek economy will grow in real terms by around 2 per cent per year and that the country will achieve an annual primary surplus (budget surplus before interest payments) of slightly more than 4 per cent of GDP.

• In addition, interest costs for Greece are very low. As a result, shrinking debts are accompanied by rising economic output.

• According to the Troika, debt levels in relation to GDP will decline by around 7 percent of GDP annually and will fall to 113½ per cent of GDP by 2022.

•Current trends confirm that the Troika’s analysis is correct.

•Competitiveness has improved and the fiscal situation is under control.

•Germany is helping to promote growth and the supply of credit to small and medium-sized enterprises by means of additional support worth up to €100 million.

•As confidence in the growing productivity of the Greek economy increases, Greece will also be able to gradually return to the capital markets.

Economic Situation has Stabilized,

• Other European economies have already successfully undertaken similar adjustment processes in the past. Belgium was able to reduce its public debt from 134 per cent of GDP in 1993 to 84 per cent of GDP in 2007.

• In the 1990s, Italy achieved an annual surplus of revenue over spending of over 4 per cent of GDP and was able to significantly reduce its debt levels. 

• Ireland, whose public debt currently stands at around 123 per cent of GDP, is already able to place sovereign bonds on the capital markets, having successfully carried out key structural reforms.

• Eurozone has already made its own tangible contribution to boosting Greece’s debt sustainability and supporting the gradual return of the country to the capital markets in the period after 2014.

• The (already approved) extension of the maturities of the issued assistance loans and the reduction of the interest burden provide relief that will eventually make it possible for private investors to purchase Greek government bonds once again.

• A new debt write-down would destroy the growing confidence in Greece and must be rejected for this reason.