Time Running Out For Greece

23 Jan 2012

Peadar o Broin

Negotiations are currently underway in Athens on a ‘Private Sector Involvement Plan’ (PSI+), i.e. the restructuring of part of Greece’s debt stock. The aim of the talks is to agree voluntary debt swaps by bondholders in order to alleviate some of the Greek debt burden. Bondholders are being asked to voluntarily swap their old bonds (the Greek debt they currently hold) in return for new bonds, which will be worth less. This ‘soft’ restructuring is considered less risky for investors than a default scenario that will inevitably come to bear unless Greece can reduce its debt burden. This is similar to the approach adopted by Uruguay in 2003 after the country’s financial system was adversely affected by fallout from Argentina’s default in 2002.

There are basically three sets of negotiators: private creditors (including most of Europe’s major banks), which are represented by the Institute of International Finance (IIF); the euro area states, including the Greek government; and the ‘troika’, composed of the International Monetary Fund (IMF), the European Commission and the European Central Bank (ECB). Ostensibly only Greece’s private holdings are up for restructuring – €206bn in total – which has raised questions as to creditor inequality should the ECB be ring-fenced from losses.

The major stumbling point in the negotiations that took place over the weekend concentrate on the interest rates the new bonds will carry.  Local Greek newspaper Kathimerini reported that the Greek government has proposed a bond swap that would offer private creditors new bonds with a 3.5% interest rate for 2014 maturities; 3.9% for 2020 maturities and 4.6% for post-2021 maturities. The bonds would be governed by English law – a key requirement of private creditors. However, two key negotiators from the IIF left Athens on Sunday afternoon without agreement, although technical discussions are due to continue over the course of this week. Key concern for the euro area and the troika is Greece’s debt sustainability – if interest rates are too high, it is unlikely that the soft restructuring will have any meaningful impact on alleviating Greece’s debt burden. But private sector officials have said they have reached the limit on what can be accepted.

According to the WSJ, the real deadline, however, is March 20, which is when Greece will have to pay a €14.4bn bond. Greece does not have enough cash in the state coffers to foot the bill, adding additional pressure to the negotiations on debt restructuring.

The WSJ also points out that to make the deal work, Greece will require an additional €60bn in emergency funding from the EU/IMF to recapitalise Greek banks that will teeter on the verge of collapse following the 'voluntary' losses.

The fast-approaching Greek bond maturities and failed attempts to reach an agreement with the IIF have pressed the Greek government to consider a ‘hard’ restructuring as a failsafe in case the PSI+ talks fail. This consists of retrofitting Greek bonds with so-called ‘collective action clauses’ (CACs) that can be invoked to compel forced losses in circumstances laid down in the bonds’ new terms and conditions. This is only possible on Greek bonds governed by Greek law – which, luckily for Greece, applies to the vast majority of its debt stock. In the case of foreign law bonds, the Greek government is unable to unilaterally alter the terms and conditions of the bonds – a key point that helps explain why private bondholders are seeking their new ‘haircut’ bonds to be governed by English law.

But a hard restructuring would undoubtedly trigger credit default swaps, leading Greece further down the road to default. Goldman Sachs, however, are more positive on the outcome of a soft restructuring, believing that it would reinforce the euro area’s “weakest link”. According to Francesco Garzarelli from GS, “between now and 2014 a significant part of Greece’s debt will move from private sector hands to euro area institutions, while at the same time an agreement on public finances will apply to all Member States that will impose common debt rules. This agreement on public finances will help to transform old sovereign bonds […] into a common euro area debt. This will avoid the entire [euro area] from being threatened by its weakest link”.

It’s not clear which “agreement” creates a common debt pool – perhaps GS is referring to the ESM Treaty that should be ready in the first half of 2012 along with the new fiscal treaty. It is true, however, that by 2014 most of Greece’s debt will be in the hands of EU institutions. This does provide greater security for the euro area as a whole – but it basically transforms Greece into a ward of those institutions, which will undoubtedly call for greater austerity in order to secure their money. This will require Greece to implement painful reforms while its economy works to service the country’s debt burden – something that can be all too easily jeopardized by a weakening of political commitment to such measures.

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