Halve Greek debt and keep the eurozone together

26/1/2015

By Reza Moghadam*

Any salvation new drachma might offer would be preceded by years of purgatory, writes Reza Moghadam

Can Greece continue in the eurozone? That question is at the centre of a campaign of innuendo, threat and counter-threat playing out across Europe. It is a dangerous game.

The leftwing Syriza party, thrust to power in yesterday’s parliamentary elections, insists that austerity must end and official creditors must accept that some of Greece’s debt cannot be repaid. This message resonated with depression-weary voters. But it has elicited stern pronouncements from politicians in Berlin, commissioners in Brussels and central bankers in Frankfurt, who say such demands are inconsistent with euro membership. Everyone insists this is a debate about policy, not about Greece’s future in the euro. But talk of a Greek exit is back in the headlines.

The Europeans’ capacity to countenance, and even contribute to, the rhetoric of a Greek exit has been strengthened by market signals suggesting that an exit from the euro would damage Athens more than its partners. Asset prices have tumbled in Greece, but in the rest of the eurozone they have held steady. A banking union has taken shape. The European Central Bank has promised quantitative easing, in the form of across-the-board purchases of sovereign bonds. And Mario Draghi, ECB president, has offered reassurance with his pledge to do “whatever it takes” to protect the single currency.

A Greek exit is in no one’s interest. For Greece, whatever salvation a new and weaker drachma might offer, would be preceded by years of purgatory — bank runs, broken economic relationships, aggravated social strife. For Europe, breaking the taboo of euro exit will probably cause markets to reassess their benign view of other weak eurozone economies and the risk of contagion between them. If Greece leaves, Europeans can forget about collecting on their debt, which would be even less sustainable with a much depreciated drachma. But denying the possibility of a Greek exit is not enough. A credible solution is needed to prevent miscalculation and accident at the precipice.

Despite massive fiscal adjustment and the largest private sector debt restructuring in history, the Greek national debt has risen to 175 per cent of output. Current plans call for the primary fiscal surplus, which excludes the cost of servicing debt, to rise from 1.5 per cent of gross domestic product in 2014 to 4.5 per cent in 2016 and beyond. This would threaten social cohesion and wreck any prospect of economic recovery. Politically, it is out of reach. Meanwhile, the debt overhang is holding back investment and public confidence.

To turn this around, Europe should offer substantial debt relief — halving Greece’s debt and halving the required fiscal balance — in exchange for reform. Conditional and phased relief could aim to bring Greek debt down to the European average in three years. This would be consistent with debt “substantially below 110 per cent of GDP”, which the IMF pushed for and eurozone ministers agreed to in 2012. And it would not rely on what have proved to be over-optimistic assumptions on Greek growth, inflation, fiscal effort and social cohesion. (I have to take my share of the responsibility here, having been involved in troika discussions between 2010 and 2014.)

Greece should offer to end its foot dragging on structural reform. Syriza, which stands outside ruling elites, may be more willing than its predecessors to push through reforms. Its hand would be strengthened by relief from austerity, and the political fillip of debt relief. Greece’s primary surplus is already close to 2 per cent of GDP, the level needed to make the government finances sustainable once debt relief has been agreed. As an incentive to reform, most proceeds could be allocated to social spending.

Debt relief will be difficult — not least because it would have to come from governments subscribing to the European bailout funds (the private sector debt already took large haircuts in 2012). Official creditors are constrained by their own politics: aid for Greece, which brought on its own crisis through fiscal profligacy, is a hard sell. Yet Greece has made huge efforts and sacrifices — with too little to show for it. Official sector debt relief in the context of a strong and credible programme is hardly a novel idea. Pragmatists floated it in 2012.

The eurozone has overcome its taboos over bailouts, private debt restructuring and banking union. Just as Syriza needs to overcome Greece’s reluctance on deep structural reform, Europe needs to overcome its taboos on debt relief.

*The writer is vice-chairman of global capital markets at Morgan Stanley and former head of the IMF European department

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