‘No’ is not the end for Greece

By: | Published: July 8, 2015 12:23 AM

So, the Greek referendum has given a resounding ‘No’ to the continuance of austerity package.

So, the Greek referendum has given a resounding ‘No’ to the continuance of austerity package. While such a referendum does not immediately threaten the breakup of the euro, there are fears of it stirring up a hornet’s nest. However, we believe that this verdict may trigger the beginning of a debt forgiveness/restructuring similar to what happened in the 1980s and pave the way for a better pay-off matrix for both the creditor and the debtor.

Interestingly, on July 2, the IMF published its debt sustainability report, according to which “the 3-year financing need from October 2015 to December 2018 amounts to about 52 billion euros … Using the thresholds agreed in November 2012, a haircut would be required to meet the November 2012 debt targets…” Using the same line of reasoning, a better negotiation may pave the way for Greece staying in the eurozone. Not many are aware that the former Greek finance minister, Yanis Varoufakis, is a game theory expert and hence understanding a pay-off matrix for the debtor and creditor may be the best foot forward!


Historically, we have examples where debt restructuring and debt waivers have paved the way for economic recovery. The Latin American countries languished through the 1980s under the burden of debt and extreme economic crisis. When it was clear that some form of debt relief was urgently required to pull out the economies from the “lost decade”, in 1989 the Brady Plan was executed which helped the debtor countries pay much of their outstanding debt with a smaller face value of Brady Bonds. Each Brady country negotiated the specific terms and details of its Brady restructuring during discussions with its commercial bank creditors, who were offered a resulting “Menu of Options” for their exchange of eligible debt. Germany’s debts were roughly halved in 1953, as a debt service ratio of 3.35% and a debt-exports ratio of 85% (1952) were considered unsustainable. Greece and Ireland were among those forgiving German debts. In addition, Article 5 of the London Accord exempted some claims totally. Article 5.2 postponed the settlement of claims of victim countries originating from World War II forced loans and occupation costs these countries had to finance until the final settlement of the question of reparations.

In terms of a simple mathematical example, let us model a debt waiver scheme for creditors and debtor (Greece). We make the primary assumption that without investment Greece will not have the resources to pay off a loan in the following period. The government is then assumed to pay off as much as it can, and to default on the rest. Next, we assume that initial repayment capacity of Greece is zero, which means Greece is in no shape to pay any amount of the 323 billion euros current outstanding debt. Alternatively, the entire cost is sunk if further loan is not extended. This means Greece will have to be provided with 52-billion-euro loan (due to her from consolidated sources) that may not be repaid without a debt waiver.

Now, assume that an investment opportunity is available in which 52 billion euros invested today will increase the debt servicing capacity of Greece from nil to 15.4 billion euros in the future. Notably, this will be purely beneficial only for creditors. So, Greece will have no incentive to forego current consumption (52 billion euros) and increase future capacity. This can only happen if the creditor gives a relief of 50% on 52 billion euros (assuming a 0% return on rate of investment and a time discounted rate of 50%). In this case, Greece will have to pay the creditor only 7.7/9.47 billion euros and not the full amount. Alternatively, if Greece had consumed the entire amount of loan extended, the creditors would have been indifferent between extending any further relief or not. So, by agreeing to debt relief, the creditors effectively increase the repayment from nil to 7.7/9.47 billion euros.

It thus appears that to bolster the confidence of Greece to undertake measures for bettering its economy and at the same time encourage it to repay the loan, the IMF and other creditors should restructure the existing debt and also provide further debt on concessional terms. This apart, there are other solutions like internationalising the basic principles of US municipal insolvency (Chapter 9, Title 11 USC), a special procedure for debtors with governmental powers, an arrangement within the ECB (or any other institution), such that in the event of a default it could step in and offer all holders of debt issued by the defaulting country an exchange against new bonds it issues. This would require creditors to take a uniform “haircut”, or loss, on their existing debt in order to protect taxpayers.

Clearly, ‘No’ is not the end for Greece, if global experience is any indication.

(Shambhavi Sharma & Disha Kheterpal contributed to the article)

The author is chief economic advisor, State Bank of India. Views are personal

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