A response to the current situation and thoughts on a possible solution
by Kanad Bagchi
Amidst the worsening situation in Greece, the IMF on 14th July updated its preliminary debt sustainability analysis on the country’s public debt, classifying the same as “highly unsustainable”. The alarming tone of the present report reflects the dramatic change of events in the last two weeks characterized by bank closures and capital controls, further strangling an already distraught economy. It documents public debt in Greece to hover close to 200 percent of GDP in the following two years, significantly above earlier projections of 124 percent by 2020 and suggests that far reaching measures are required to be undertaken as opposed to what is being currently considered within EU circles. The timing of the report is also crucial especially in the light of the recent agreement among the Eurozone Member States (“MS”) to back Greece with a new bridge loan of 7 Billion euro and ECB’s pledge to raise the limit for its Emergency Liquidity Assistance to Greek Banks. In addition to that a new round of deliberations is slated to begin between the EU partners and Greece over a possible third bailout to the tune of 86 Billion to be disbursed in the next three years. As much as the EU and more generally the world economy would like to extricate a speedy solution to the present crisis, it is important to unwind and take a leaf out of history to consider the efficacy and suitability of the above mentioned approach. In this regard, the author is poignantly reminded of the events in the year 2012, when Greece, after an unwarranted and potentially disastrous period of delay and political indecisiveness was finally subjected to a debt restructuring exercise of magnanimous proportions. It envisioned a 53.5% reduction in face value of the principal amount of 135 bond series, along with the exchange of new low-coupon Greek bonds with maturities of 11 to 30 years for the remaining 31.5%. Along with that two-year ESFS notes were substituted for the rest of the 15% of the face value of the bonds. In the end, several estimates put the total loss to investors to the tune of 70 – 75% of the Net Present Value of the bonds. Despite repeated calls from the IMF to trigger the process of debt restructuring as early as 2011 in return for further contributions, the EU remained in abject denial and continued negotiations on a lighter version of a ‘private sector involvement’ which ultimately was never put into force. Scholars have claimed that a restructuring of Greek debt towards mid 2011, by which time, an exercise of that nature was deemed unavoidable could have saved an additional 10 billion Euros. The IMF had consistently expressed concerns regarding Greece’s debilitating finances and the urgency of debt relief only to receive severe resistance from both the ECB and EU leaders. Consequently, in what was termed as an exercise, which was ‘too late and too little’, despite being a debt restructuring operation of unprecedented proportions, both as regards its total amount and creditor losses, left much to be desired for. The hurried restructuring was inadequate in its design and cumbersome in its execution, resulting in unmitigated losses and exposed EU taxpayers to immense uncertainty and danger. Several studies post the 2012 restructuring have highlighted that ‘delay’ and ‘self denial’ were the two most prominent reasons for the restructuring’s ineffectiveness in putting Greece on the path of debt sustainability.
The prevailing situation in many aspects displays an uncanny similarity to the yesteryears and calls for a careful consideration of various options available to Greece and the EU. In this regard, the present IMF report meticulously considers three possible alternatives in the circumstances, which presently confound EU and Greece. First, a rescheduling of the total outstanding EU debt with extreme grace periods to the tune of 30 years. Second, direct annual transfers to the government budget of Greece and as a third measure, ‘deep upfront haircuts’ or a face value write off. While debt rescheduling appears to be the most politically viable alternative, especially in the current friable dynamics in the EU, it leaves much to chance and even more to wavering political compulsions in Greece. It is anybody’s case that even after two bailouts and a massive debt restructuring entailing a voluntary write-off to the tune of 53.5% of face value of the bonds, Greek debt as it stands today still remains unsustainable. Further, a third bailout with resulting fiscal and budgetary conditionality’s increases the tendency of Greece inching towards and remaining in the ‘high-debt and low-growth trap’. The constraints of the Economic and Monetary Union, pose a veritable obstacle in considering the second option, that of direct transfers to a MS budget, Greece in the present case, without further European Integration in the form of a Fiscal Union. A second debt restructuring, however, is both economically prudent and most likely imminent to ward off a continuing crisis in the medium to longer term. With respect to this, the author finds himself in good company, in as much as the IMF also disputes the medium and long-term sustainability of Greek debt in the absence of a consensus on some form of debt restructuring. Unlike the 2012 operation, any attempt at a restructuring in the present circumstances is likely to be limited in its complexity in so far as, a significant portion of its debt is held by EU institutions, different MS and the European Financial Stability Facility. Therefore collating the various creditors groups and hammering out a suitable deal is far more feasible and way more efficient. Further, any debt restructuring plan, in the present circumstances is unlikely to be inhibited either by collective action problems or funding constraints as most of Greek debt is held by the official sector and commitments are underway for additional financial support.
In this regard, the author ardently calls upon EU leaders to earnestly explore the option of a further restructuring exercise in the light of current projections regarding Greece’s short terms and long term debts. Eurozone MS have so far displayed great resilience towards Greek fallibility, and the recent offer of a bridge loan is a further indication of their pledge to preserve the Euro and salvage Greece. In IMF’s estimation, even with an additional 85 billion Euros in loans to Greece over the next three years, its debt would still remain unsustainable unless certain extraordinary steps are undertaken. A suitable debt restructuring at this intervening stage, could potentially provide Greece with a much needed breather and allow it to wholeheartedly implement its past reform pledges. So far along with the IMF, both the US Treasury and even Mr. Schäuble, the German Finance Minister have acknowledged that any debt relief package for Greece has to resemble not just a simple debt rescheduling, but also some form of debt reduction. Germany, despite such express acknowledgment remains uncompromising on the question of debt reduction and insists for an unprecedented alternative of a ‘time out’ for Greece from the Eurozone. In its support, Germany claims that a debt ‘haircut’ would tantamount to a breach of Art. 125 (1) TFEU. On the contrary, however, it is submitted that neither a reading of the treaties nor a perusal of ECJ case law supports that conclusion. Art. 125 (1) prohibits the Union or a MS from either exposing itself to any liability, or from assuming the commitments of other central governments, Greece in the present case. The ECJ in Pringle had already ruled that the inherent objective of Art 125 (1) was to ensure that MS do not become complacent in maintaining a sound budgetary policy. The Court on that basis approved ESM loans as compatible with the article as strict budgetary conditions were a part of the package consisting of ESM loans. With respect to this any debt restructuring exercise inevitably involves an agreement on a number of conditions, mostly unpleasant and painful, between the creditors and the debtor state. Austerity measure, tax increases, government job cuts, labor law reforms and liberalization of key industries, only to name a few, are constituent elements of any debt restructuring operation, the sole objective of which is to ensure that the MS are not inclined to disregard the maintenance of sound budgetary policy. Therefore, an argument suggesting that any debt restructuring plan simplicitor, is a violation of Art 125 (1) is to impute a meaning to the article which the treaty does not envisage. What is crucial however is to evaluate the conditions appended to the debt restructuring plan and assess whether those conditions result in weaning MS from pursuing sound budgetary policy. It is urged that a possible debt restructuring, which is manifesting itself to be both unavoidable and imminent, requires the Eurozone’s immediate attention and unwavering commitment, lest it may find itself in similar debacle as it did in 2012. Moreover, it is crucial to take the IMF, with its resources and expertise, on board with respect to any future bailout mechanism in the EU, a commitment that it is only willing to make in the event of a debt restructuring for Greece. In the face of tremendous market speculation and investor fright, a debt restructuring commitment on the part of EU would send out an unambiguous message that the ‘Union’ is here to stay and that the present crisis is only a temporary impediment against the pledge of an ‘Ever closer Union’.
 Kanad Bagchi (email@example.com) was formally a research assistant at Europa-Insitut, Universität des Saarlandes, Germany. Currently he is preparing to continue his studies at Oxford. Views of the author are his own and should not be imputed to the institution he used to represent.