Don Alexander, MBA
Associate, RSD Solutions Inc.
European politicians, when creating the euro, failed to consider the risks of their actions. Policymakers looked at developments in Greece as a temporary liquidity squeeze rather than a solvency crisis. Paolo Manasse wrote on this issue in a voxeu communiqué called “Greece, The Unbearable Heaviness of Debt”. He noted analysts have been arguing that Greece will default on part of its debt – leaving its creditors to take a “haircut”. Manesse argues the prospect is becoming more likely.
S&P further downgraded the junk rating of Greek debt reflecting the larger than projected budget deficit and the unsustainable growth rate of government debt. They estimate a 50% haircut may be required to restore solvency. There are expectations of a euro 50-60 billion loan from the EU/IMF, which at best may provide temporary relief. Currently, the only other alternative to debt restructuring, is to leave the euro which seems extremely unlikely. The rising interest rate on Greek debt combined with new debt issuance/borrowing indicates that the stock of debt is growing much faster than GDP, which is not sustainable.
Currently, there are three potential tools to make Greece’s debt sustainable: lowering the interest rate on outstanding debt, turning the primary deficit into a surplus, or writing down the existing debt stock. A reduction in the market rate may provide a cushion for Greece. Any move to a primary budget surplus would most likely cause social unrest. The most likely scenario would be restructuring plus new money at a concessionary rate. Eurozone bank exposure to sovereign Greek debt is estimated around $100 billion according to the BIS. Any write-down of Greek debt along with the need to recapitalize the banks will be an expensive lesson on risk management.
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