Greece's Pieces

After nearly four months of negotiations, near misses, bouts of despair, and growing acrimony, the eurozone finally gave its blessing to Greece’s second bailout. It is a huge 130 billion euro package, accompanied by a debt writedown and strict austerity requirements. In a 13-hour-long meeting yesterday, under intense pressure from Germany and the Netherlands, Greece’s private bondholders were forced to take a larger haircut than originally planned—53.5 percent rather than 50 percent. This, according to the International Monetary Fund, will bring Greece’s debt down to 120.5 percent of GDP by 2020. A confidential debt analysis distributed to officials last week found that with a 50 percent haircut, Greek debt would only fall to 129 per cent by 2020, and the package would cost official creditors 136 billion euros—hence the further arm-twisting of banks to take deeper losses.

A great deal remains to be done before March 20, the deadline for a 14.5 billion euro Greek bond. National parliaments of eurozone members must approve the new package, contingent upon Greece passing a raft of measures (79 in all) by the end of the month implementing the new terms. These measures include cuts in salaries and pensions, restrictions on collective bargaining, the slashing of a wide variety of welfare benefits, and reduced spending on defense and public investment. Not exactly popular stuff.

In addition, thorny details need to be ironed out regarding the precise nature of the increased monitoring of the Greek adjustment program, demanded in particular by the triple-A-rated countries of the north (Germany, the Netherlands, Finland). This monitoring includes the working of a “segregated account” reserved for debt servicing, which will be given priority over all other spending through legislation in the Greek parliament.

Meanwhile, Greece’s private creditors will be mulling the bond exchange offer made to them by the Greek government—it is expected in the next few days—as part of the Private Sector Involvement (PSI) process. Later this week, the Greek government is also expected to pass a law retrofitting Greek bonds with Collective Action Clauses (CACs), thus giving itself the option of forcing recalcitrant creditors to participate in the bond exchange, if those entering into it “voluntarily” are too few.

Whether the CACs are activated or not will depend on the level of private-sector participation and on the debt relief provided by the “distribution of profits” from Greek bond holdings bought on the secondary market by the European Central Bank (ECB) and national euro area central banks. At the moment, it seems highly probable that the CACs will be activated. This, in all likelihood, will turn the Greek restructuring into a credit event and will trigger CDS payments, the consequences of which—especially if there exists a systemically important financial institution that will find itself in real trouble—are hard to predict.

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The two processes—the loan package and PSI—are inextricably intertwined. As part of the PSI deal, Greece’s private lenders are set to receive, upfront, two-year EFSF bonds worth 30 billion euros. They are also to get 5.5 billion euros in interest payments from the old bonds that they will trade away. Then there’s the small, nagging question of the continued existence of Greek banking. The balance sheets of the country’s banks will be devastated by the debt haircut. To prevent a meltdown, 23 billion euros will be put aside by the European Financial Stability Facility (EFSF) for immediate recapitalization (according to the IMF’s debt analysis, the total cost in the long-run will be 50 billion euros). Another 35 billion will be used as “credit enhancements” to ensure continued liquidity support from the ECB for the (short) period during which Greek bonds will be downgraded to a status of “selective default” and hence will not be eligible as collateral for lending by the European bank to Greece’s financial system. All in all, that’s 93.5 billion euros that needs to be approved in the next few weeks by national parliaments, or the debt haircut will be stopped in its tracks.

Even if all this goes smoothly, it is far from plain sailing ahead for Greece (nor, by extension, for its creditors, both private and public). Early elections, to be held probably in late April or early May, will be closely watched by those of the country’s European partners who are convinced that the Greek political system cannot mend its ways and that, therefore, it would be better for the eurozone to continue without Greece. Hawks in Germany, the Netherlands and Finland will be looking for any signs of backtracking from the commitments of the new loan agreement in the heat of the election battle. A first crucial test for the new Greek government comes in June, when further cuts will have to be negotiated, including possibly (yet again) in pension benefits.

Looking further forward, the main worry is that the new program does little to tackle Greece’s depression, and will probably make it worse, at least in the short-run. The country, which has been in recession since 2008, saw its GDP fall by nearly 7 percent in 2011, and the economy is expected to contract by at least another 4 percent this year. Unemployment is already at 20.9 percent (including a staggering 48 percent for young people) and is going further up. The social fabric is badly frayed and the wider economic climate in Europe is poor (eurozone GDP fell by 0.3 percent, in the last quarter of 2011).

Even so, the new commitment by the eurozone to support the country should push back the spectre of default for long enough to give Greece a chance. The optimistic scenario is that a restructured banking sector will slowly start lending again and investment will start trickling in as the fear of a euro exit recedes. Structural reforms will aid the process of recovery along, making investment more attractive and helping the long-suffering population, for example by tackling rigidities that prevent prices from falling in these tough times and by opening up job opportunities in sectors that were until now closed off from competition. It is a tall order but, if things play out like that, Greece will be able to stand on its feet again, on much firmer ground than before. And Europe will not have to deal with a catastrophe that would create a new source of instability in an area—the Eastern Mediterranean and the Balkans—that has more than enough of it to go around.

Comments

Good article. I assumed the creditors would want their CDS activated, notwithstanding their "voluntary" participation in the program, and would figure some way to make that occur.

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