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Averting their ‘Lehman’ Moment
The current Bailout might help Greece avoid a default – The ‘Lehman’ Moment – for now, but Their Mounting Debt will come back to haunt The Economy in the near future.
Issue Date - 18/08/2011
The eurozone as a complex financial experiment has been one of those setbacks which never ceases to bewilder. It all started with Greece. The country, which joined the eurozone in 2002, was considered as one of the most lucrative economies during the early 2000s. And why not. At 4.2%, it was among the fastest growing eurozone nations. Though inflation was hovering at around 4%, but then it was considered ‘controllable’. Simply amazing, except for the fact that the country had fudged its entry into the eurozone (as revealed by revised Greek budget data in November 2004). Greece’s budget deficit had never been below 3% since 1999 – a violation of EU rules. The rest as they say is, or, will be history. A slew of events starting with austerity measures, the global economic meltdown, rising national debt and a widening deficit resulted in Greece declaring bankruptcy in 2010. A bailout package of €110 billion to finance the country’s borrowing needs up to 2013 was agreed upon. However, eurozone’s hopes of seeing Greece return to private markets in 2013 went down the drain when on June 19, 2011, the latter demanded an additional €110 billion to insulate itself from defaulting on debt.

On July 21, 2011, member states of the eurozone council led by Germany’s Chancellor, Angela Merkel were summoned for an emergency summit in Brussels. The outcome of the meeting went far beyond what was expected – apart from a new bailout package of €109 billion, the beleaguered economy was granted relaxation which will at least ease its debt burden to some extent. While the repayment period has been pushed to 15 years instead of the previously decided seven years, interest paid by Greece on bailout funds has been reduced to 3.5% from the current 5%. Thanks to the new package (which takes up the total bailout amount to €200 billion), Athens will not default on its debt, not in the near future. But that doesn’t stop it from making a selective default in the mid term. As part of this deal, private investors will need to cough up €28 billion of the €109 billion. In case the private sector incurs a loss, it would be considered a default (that’s precisely the reason Moody’s has downgraded Greek bond rating to Ca, one notch above the default rating). The Hellenic Republic’s private creditors have also agreed to contribute €50 billion in debt relief. This would be done by primarily rolling over maturing bonds and participating in a buyback that would facilitate Greece to retire €33 billion of debt at a discounted rate of €20 billion.

These measures have sent out a strong message – the Europeans are willing to do anything to keep their ‘Union’ intact. But they couldn’t disguise the disconcerting reality – Greece is still a mess. Nevertheless, investors did give the bailout a benefit of doubt – yield on 10-year government bonds and two year notes declined by 300 bps and 1,000 bps respectively in the week following the second rescue plan, stock markets rallied and Euro rose 2% against the dollar.

Despite this, the question remains – Is Greece finally out of the woods? Well, let’s see how the numbers stack up. Athens’ fundamental problem is its mounting debt, which currently stands at €340 billion. In 2010, for the first time, debt-to-GDP ratio exceeded 140%. This, as estimated by the European Commission, is expected to reach 158% by the end 2011 and hover around 166% by 2012. As estimated, under present economic dynamics, Greece’s debt will come down by just about 12% (we wonder how that’s going to help). To be honest, the mounting debt-to-GDP ratio only stabilises and comes down under two scenarios – a 7.5% GDP growth rate (ratio comes down to 80% by 2030) or a 5% primary surplus (ratio declines to 120% by 2030). Sad part is, under the contours of the economic environment in the eurozone and most of the West (coupled with Greece’s strong austerity measures of course), neither of the scenarios is practically applicable. Agrees Jay H. Bryson, the US based Global Economist at Wells Fargo Securities, as he tells B&E, “It would not be credible to consider the Greek debt crisis solved yet. Under our base-case scenario of 3.5% long-run nominal GDP growth and a 3% of GDP primary surplus, the debt-to-GDP ratio of the Greek government will stabilise at around 160% of GDP. But if these favourable conditions do not materialise, the Greek debt problem will raise its ugly head again.”

Economists might not clearly opine, but as the figures suggest, there is no solution to this in the foreseeable future. In fact, we might see Athens asking for yet another bailout in 2012. With every passing year, the cost of restructuring will also rise. If today, the country’s debt were to be brought down to sustainable levels, half of it would have to be written off. Two years later, the cost of achieving the same would rise to writing off two-thirds of debt. Ideally, eurozone members should reconsider their action plans, which should include considering taking over financial administration of Greece completely from its politicians; and if not, pondering over whether Greece should remain a part of eurozone at all.

Amir Moin           

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