Debt Issue in Greece

Debt Situation in Greece

Introduction

In May 2010, the Greece government requested a financial bailout from the IMF and EU.  The government signed a memorandum of economic and financial policies for a three-year program with the so-called “troika:  made up of the IMF, the European Commission and European Central Bank.  The IMF approved a loan for Greece in the amount of 26. Million dollars over next three years, presently Greece has received 17.5 million from the IMF.^[1]  Per IMF’s website in a transcript of a press briefing on Greece consisting of members of the IMF, European Central Bank (ECB), and European Commission (EC) in Greece provided several suggestions on how Greece can achieve stability in the country.  The parties suggested severe reform in government and private sector is in dire need to reduce corruption.  The structural reform will concentrate on areas in the healthcare, public enterprises, tax administration, privatization of state assets, and public enterprises.^[2] 

The EU-IMF program had the dual of undertaking a large fiscal adjustment to address fiscal insolvency and, simultaneously, achieving “internal devaluation” to close the competitiveness gap.  However, it soon became apparent that the program implementation was lagging behind schedule.  To date, more than 20% of deposits have been lost since the beginning of the crisis in early 2010.  Bank’s access to international capital markets has also been shut off.  At this present time, they rely fully on the ECB’s funding via regular open market operations and the Greek central bank’s emergency liquidity assistance.  Briefly, I will approach the factors involving the debt situation in Greece.  Before drawing a conclusion I will give a brief summary of the consequences and their effects.  

The Bailout Program

In the 2011, European Summit agreed on a new program to assist Greece in this crisis, the agreement between the IMF, and private sectors to provide financial assistance to Greece for €190 billion ($230 billion).  The European Financial Stability Facility (EFSF) will be dispersing the next amount and the ECB and the IMF will monitor Greece very closely.^[3]  In May 2010, they signed a three-year program, which would provide EUR80bn from Eurozone countries and EUR30bn from the IMF.  So, that Greece was able to pay the urgent debts back and to avoid a declaration of bankruptcy. But it was just an emergency assistance and it was obvious that Greece would need more money.  

That’s is why in 2010 the European member states also founded a temporary institution called the European Financial Stability Facility (EFSF).  The second bailout loan confirmed Greece 16.4 Bn. € till 2014.  But, Greece don’t get this bailouts for free.  These are loans with additional requirements for Greece.  Since, 2010 until today there were 6 austerity measures.  They are meant to close the nation’s budget, lower its huge debt burden and make its economy more competitive.  There is an endless list of savings and political reforms.  For example of the first four austerity packages and the VAT was set from 19% to 21%.  

The euro-zone national banks, the ECB, the IMF, and European governments holds more than 50% of Greece’s bonds.^[4]  Because public institutions are holding more than 50% of Greece’s sovereign debt and the country’s debt is increasing daily, it is possible Greece will become insolvent and will be unable to pay off its debt; this could mean that taxpayers would end up footing the bill.  Greece is so in debt that the country is unable to redeem the bonds because Greece can only redeem the bonds when the country receives its bailout dispersement but it is not enough to put a dent into the country’ debt.  

Greece’s Debt

Greece’s debt problems consist of a variety of mistakes and issues including profligate spending, corruption, overpaid positions, tax evasion, and large pensions, etc.  One rule when joining the European Union (EU) is an understanding each country is to keep the country’s budget deficit within 3% of GDP.  Later, after Greece joined the EU its budget deficit was actually around 13%.^[5] Greece tried to handle its debt issue until the EU decided further action needed to be taken. The program proposed a fiscal path with measures worth 7.5% of GDP in 2010; 4% in 2011; and 2% of GDP in both 2010 and 2013.  The aim was for debt/GDP to peak at 150% by 2013 and to decline thereafter.  The program also included several long-term structural reforms to unlock Greece’s growth potential.  

For Greece to recover successfully they need sustainable opportunities to fix their debt crisis to avoid defaulting out of the euro. Suggesting that the Greeks need to see opportunities to increase confidence to expand out of their recession.  As Greece’s debt currently exceeds their GDP at an outgoing rate of 165%, it’s absurd to claim that they can pay that off in a short time span even with the help of 3rd parties and cooperating countries.  Instead, involve a series of paths to lend funds towards the Greeks to restructure their debt and not give them assured debt reduction finances until they have met certain performance criteria.^[6] This of course will take a series of series of years to fully reduce their debt crisis, but it’s a rational way out for the Greeks to effectively reduce the volume of debt they owe.

Greece Upholds the Euro

The pros are that a return to the old currency like the drachma would have the effect of depreciate in value, it would become more competitively in price, and this would boost the Greeks exports.  With Greece the euro, this could lead to higher risks of the problem happening, politically and economically.  No doubt this would be contentious for further cognation of the European Union and would lead to an abundance of un-predicted events for the euro itself.^[7]  If Greece was to abandon the euro and convert to their old currency (drachmas) successfully in the global market, this could turn to other countries with a severe deficit potentially wanting to do the same.^[8] This exemplifies the vast un-predictability of Greece separating, which in turn could lead to the euro and the rest of the European economy being depreciated and negatively affected.  

Debt Restructuring

A useful approximation of recovery values using a haircut calculation can be obtained by assuming that all current Greek bonded debt to restructuring would be represented by one synthetic bond paying a coupon of c.5.15% (the average interest rate of Greek debt) with maturity of about eight years (the average maturity of Greek debt).  Assume that in a restricting, the notional principal of bonds included in the restricting is reduced by a given percentage.  The potential haircuts involved in the debt restricting calculations are very high relative to past emerging market defaults.  Part of the problem is that markets underestimated the costs and overestimated the benefits of euro area membership.