* IMF participation in a programme is conditional on a restructuring *
By Fergus McCormick
In the event of a Greek departure from the Eurozone, a default on both official sector debt and debt held by the private sector would very likely occur. For the foreseeable future, a more likely outcome is that Greece remains in the Eurozone. The recent tentative agreement between Greece and its international creditors to negotiate a third financial support programme, makes it more likely that in the near term Greece will avert the adoption of a new currency to replace the Euro. However, for the programme to work, some debt restructuring appears necessary.
The aim of the programme is to restore fiscal sustainability, financial stability and long-term growth, and bolster market confidence, so that Greece can return to the private capital markets to meet its funding needs. Importantly, a recovery is needed to restore macroeconomic stability. If the economy does not recover, the debt burden will inevitably continue to increase. The Greek Parliament has already approved two rounds of fiscal, legislative and structural measures required by the creditors. In return, recent interim financial support from the European Stability Mechanism (ESM) and European Financial Stabilisation Mechanism (EFSM) has allowed Greek banks to reopen, some capital controls to be relaxed, Greece to repay the ECB and to clear its arrears to the IMF.
As the terms of the three-year EUR 82-86 bln ESM loan facility are being debated, some form of debt restructuring is also being considered. If a restructuring occurs, it would likely only involve official sector loans. This contrasts with the 2012 restructuring, which included both haircuts on private bonds and the extension of maturities and deferral of interest on official sector debt. So far, the design of a second restructuring has yet to be determined. Nevertheless, there are three reasons to expect a restructuring to be forthcoming.
1. The debt burden is unsustainable
DBRS shares the widely held view that Greece’s debt burden is unsustainable. This is as much a function of low growth prospects as it is of debt service payments: without a return to sustainable growth Greece’s debt burden will only increase. The damage to the economy after six months of negotiations, two missed payments to the IMF, three weeks of capital controls, a popular referendum, and an abrupt acceptance by Greek negotiators of deep adjustment measures has been significant.
GDP is expected to decline this year between -1.0% and -4.0%. The extent of the deterioration will likely depend on the effect of capital controls on consumption and investment, and the impact of the expenditure cuts and tax increases that Greece must implement as part of the coming programme.
The IMF estimates that even with full implementation of structural reforms, as outlined in the July 12 ‘prior actions’, Greece’s real long-term growth rate will be only 1.5%. Over the medium term, GDP is expected at 2% to 3% as the output gap closes and confidence is restored. Regarding debt service, even if the programme is fully implemented, the IMF expects financing needs through the end of 2018 to be EUR 85 bln, well above the 15% of GDP threshold deemed safe. Under this framework, even if growth resumes, public debt is expected to peak at close to 200% of GDP in mid-2017, up from an already high 168.8% of GDP in the first quarter of 2015.
2. IMF participation is conditional on debt restructuring
On July 30, IMF staff informed the IMF board that Greece is disqualified from a third IMF programme. The disqualification was because in their view the debt is unsustainable, and because Greece has a poor record of reform implementation. The IMF staff doubts that the existing loan facility for Greece, of which there remains EUR 16.5 bln to disburse, will achieve its original targets, or allow Greece to return to the private capital markets by March 2016, when the programme expires. Therefore, the IMF will not extend any new loans under a new programme unless it deems Greece’s debt burden to be sustainable “with a high probability.” This decision is important because both the EU and ECB have expressed a lack of willingness to extend a new support programme to Greece unless the IMF is involved.
In its most recent debt sustainability analysis, the IMF stated that debt relief is necessary in Greece, either through “deep upfront haircuts” of official sector debt, “explicit annual transfers to the Greek budget”, or “a very dramatic extension” of grace and repayment periods of official debt, including new assistance. However, several creditor countries believe that official debt forgiveness is incompatible with Eurozone membership. This difference in views is one of the main reasons for the delay in a debt restructuring.
3. In the absence of debt restructuring, the success of a third support programme is doubtful
If the forthcoming support programme is to be based on the ‘prior actions’, it is doubtful that the economy will recover sufficiently to prevent the debt-to-GDP ratio from increasing. The ‘prior actions’ call for a new fiscal path to be centred on a primary surplus target of 1%, 2%, 3%, and 3.5% of GDP for 2015, 2016, 2017, and 2018. Attaining such surpluses will be extremely difficult should the economy in fact decline by -1.0% and -4.0% this year, as expected. The package also calls for value-added tax reforms, among other tax measures, pension reforms, public administration reforms, reforms addressing shortfalls in tax collection enforcement, and other parametric measures. The Parliament has already approved some of these measures, but they have yet to be implemented.
Although DBRS acknowledges that these measures would help long-term growth, in the near term, growth prospects will be subject to even more downside risk.
DBRS shares the IMF’s doubts over whether such a demanding fiscal path can be achieved. In the IMF’s words, “few countries have managed to” [maintain primary surpluses for the next several decades of 3.5% of GDP]. It is likely that once the primary balance is in surplus, the political pressures to ease the target will increase significantly, as has occurred in Greece under the previous two programmes.
Although not a direct catalyst for either a return to growth of 2-3%, or the generation of a high primary surplus, a debt restructuring would help in two ways.
First, further lowering the interest rate on official loans and extending maturities would improve Greece’s capacity to pay and help attract private sector financing. The 2012 restructuring did extend the weighted average maturities on Greece’s loans to a very long 15.7 years, and lowered the implicit interest rate to 2.4%, below the Eurozone average of 2.7%. However, Greece remains shut out of private capital markets and is wholly dependent on official sector financing.
Second, Greece is severely limited in its ability to administer further austerity measures. The political opposition to austerity among the ruling Syriza party and some of its allies, was made all the more evident with the decision on July 30 by the Syriza party to hold an emergency congress in September to vote on whether to approve the support programme. Without the full commitment of the Greek government, the programme would almost inevitably fail and an exit from the Eurozone would likely follow.
Fergus McCormick Senior Vice President, Head of Sovereign Ratings Group at DBRS [email protected]
