A Greek Short Back and Sides

Would a 50% cut in the value of Greek debt be enough?

The wall street journal

That depends on who’s losing out.

If Greece’s obligations to the European Central Bank and International Monetary Fund are considered inviolable, while Greece at the same time uses existing resources to recapitalize its banks, a 50% default will result in only a quarter of Greece’s debt load being lifted, according to a recent UBS note.

That clearly wouldn’t be enough. With Greece’s debt load expected to hit 190% of GDP next year, a 50% haircut borne by the private sector alone would still leave the country with an unsustainable debt load of some 150% of GDP.

To get to an average 50% default on Greece’s outstanding debt, while ensuring the ECB and the IMF don’t take any losses on their holdings, would mean the privately-held component of Greek debt probably being written off entirely.

But would even a 50% across-the-board debt cut be sufficient?

That would take Greece’s debt back down to 85% of GDP; still on the high side but evidently sustainable in many countries. Greek debt hasn’t been that low as a percentage of GDP since 1992. Indeed, over the past decade, the lowest Greek debt has been as a proportion of GDP was 97% in 2003, according to IMF data.

But a country’s willingness and ability to service an 85% debt-to-GDP ratio is dependent on its potential for generating income. And here, Greece’s fundamentals have to be questioned. It has an ageing population and a birth rate that during the past decade has been barely enough to offset deaths. If trends of the past few decades persist, the Greek population will start shrinking before long. Since most of the shrinkage comes from emigration and lack of births, Greece will soon be confronting the perennial developed-world problem of an ever-smaller workforce carrying an ever-larger group of pensioners.

Greece has many other structural problems too. Greek competitiveness declined sharply in the years leading up to the financial crisis as domestic labor costs rose but productivity flagged. Meanwhile, Greece has lagged Ireland in regaining competitiveness. Greece is the most corrupt country in Europe outside the former Yugoslavia and the former Soviet Union, according to Transparency International. And last year, Greece ranked 109th out of 183 countries in business friendliness, according to the World Bank.

Unless these structural problems are resolved, its prospects for significant and strong growth during the coming decade or two seem poor. And without decent growth, even an 85% debt-to-GDP ratio may prove unpalatably high.