20/6/2015
This article takes a detailed look at the forms of debt default that Greece might employ to reduce near-term financing pressures and lower its debt burden.
There are various possible options, but the scale and type of default needed to tackle Greece's debts comprehensively may not be compatible with its continued membership of the eurozone.
Regardless of whether any short-term deal between Greece and its creditors (if there is one) includes some form of debt relief, we have long argued that Greece will need to undertake a substantial restructuring or default if it is to return its public finances to a sustainable position in the long run.
In this article, we therefore examine some of the main possibilities for such action, providing a score out of five for the potential benefit to Greece, the potential damage to its creditors and the likelihood of such action (a higher number signals greater benefit, damage etc).
GREECE'S DEBT OBLIGATIONS
Table 1 (click to enlarge) provides a summary of the key facts and figures relating to the different categories of Greek debt, as well as the effects of a 50 per cent writedown on Greece's near-term financing costs and public debt ratio Treasury bills.
Greece's most immediate debt obligations are its maturing three-month and six-month T-bills, worth some €15 billion (£10.71 billion).
Defaulting on the T-bills might seem like a relatively undisruptive option. After all, they are owned pretty much exclusively by Greek banks, so the global implications of such a default and the risk of it directly resulting in Greece's expulsion from the eurozone would be very low.
But the bills are small, accounting for under 5 per cent of the Greek debt stock (see chart 1). And, provided that the European Central Bank (ECB) continues to accept their use as collateral in return for emergency liquidity assistance (ELA), the government should have no trouble in rolling them over. So such a default would gain little and could cause serious damage to the Greek banking sector.
Potential benefit to Greece 1/5; damage to global creditors 1/5; likelihood 1/5.
IMF LOANS
Greece has received some €24 billion of loans from the International Monetary Fund (IMF) as part of its first and second bailouts. Unlike some of Greece's other loans, its IMF debt has not been extended and hence presents a major financing pressure in the next few years.
Outright defaults on IMF debt are rare. But Greece has already 'bundled' its June payments into one lump sum and might at least be able to defer some payments further. Several countries are already in arrears to the IMF and have been for years.
But the political ramifications of a 'default' to the IMF would be severe. Countries now in arrears are generally undeveloped and often war-torn ones like Zimbabwe, Zambia and Iraq.
Failure to pay by a relatively rich and developed economy like Greece would be unusual and European authorities are already under strong pressure globally, particularly from the US, to ensure that IMF payments are made.
Benefit to Greece 2/5; damage to global creditors 2/5; likelihood 2/5.
ECB BOND HOLDINGS
The ECB holds Greek government bonds with a face value of €27 billion purchased under the Securities Markets Programme (SMP) in 2010 and accounting for almost 9 per cent of Greece's debt. The bonds are of varying maturities, but some €6.7 billion will mature in July and August, presenting the biggest near-term debt servicing hurdle (see chart 2).
As the ECB effectively printed money to purchase the bonds, there would be no creditor requiring immediate repayment. And the Bank has reserves and subscribed capital of €96 billion, which in theory could easily absorb even a full default on Greece's €27 billion.
But sustaining such a loss could seriously damage the Bank's reputation and therefore its ability to control inflation in future. Accordingly, we suspect that it would be recapitalised by national central banks, implying that the cost would fall on eurozone governments and ultimately taxpayers.
And in the likely event that the ECB did not condone this default, we suspect that it would withdraw its permission for the Greek central bank to provide ELA. This amounts to a whopping €82 billion, so the loss to Greece would be bigger than the benefit of defaulting on the bonds.
A softer form of default to the ECB that might allow ELA to continue would involve lengthening the SMP bonds' maturities. ECB president Mario Draghi has said that this is not an option while the Bank still holds the bonds. But if the European stability mechanism bailout fund bought them as the Greek government has proposed, they might then be restructured.
This would presumably be preferable to an outright default on the ECB debt and it would put off the payments currently due this summer. But it would do little to tackle Greece's debt load and there would be political costs involved in shifting risk from the ECB more obviously onto other eurozone governments.
Benefit to Greece 1/5; damage to global creditors 2/5; likelihood 2/5.
GREEK LOAN FACILITY
The Greek loan facility (GLF) consists of the bilateral loans made to Greece by other eurozone countries in its first bail-out. These amount to a fairly hefty €53 billion, accounting for some 18 per cent of Greece's debts.
However, the interest rates on those loans have already been reduced twice, from 300 basis points (bps) over three-month euribor, to just 50bps over, while the maturity of some of the loans has been extended all the way out to 2042.
As such, a default on GLF loans would have little beneficial impact on Greece's debt-servicing costs or near-term financing needs. It could, however, have a reasonably big effect on Greece's published debt-to-GDP ratio.
It is unlikely, though, that Greece's eurozone partners would see an outright and substantial default on their direct loans to Greece as compatible with continued Greek membership of the currency union.
Benefit to Greece 3/5; damage to global creditors 3/5; likelihood 2/5.
PRIVATE DEBT
Despite the transfer of much of Greece's debts to the official sector, about €55 billion, or 19 per cent, is still held by the private sector in the form of tradable government bonds. This might look like a soft target for a default, given that it would not lead to any international or official sector losses and associated punishment.
It might also be presented as another voluntary arrangement such as the debt exchange and haircut implemented back in 2012, with the result that it might not even be classified as a default by the credit rating agencies.
But previous maturity extensions mean that the impact on Greece's financing burden would be minimal, while major write-offs would adversely affect the Greek banking sector. For these reasons, the Greek government has pledged that it will not default on its privately held debts.
Benefit to Greece 1/5; damage to global creditors 1/5; likelihood 1/5.
EFSF LOANS
By far the biggest element of Greece's outstanding debts is the €140 billion of loans made by the European Financial Stability Facility (EFSF) in the country's second bailout in 2012. A major debt default will therefore almost certainly need to encompass some portion of those loans.
The long maturities, very low interest rates and deferred interest payments on the loans mean that the impact of a default on Greece's interest costs and redemption schedule would be minimal. But a major haircut on EFSF debts could reduce Greece's outstanding debt burden substantially.
Indeed, a full writedown of the EFSF debts would bring the public debt-to-GDP ratio down to around 100 per cent, well below the equivalent ratios for Italy, Portugal and Ireland.
Note that the recent restructuring plan recently advanced by Greece incorporated the complete writedown of 50 per cent of outstanding EFSF loans, albeit accompanied by the payment of higher interest on the other half.
The other eurozone countries act as guarantors for loans made by the EFSF and so, in theory at least, they would be on the hook for the full amount of any default. The damage need not be immediate.
Assuming that the EFSF retained financial market access after a Greek default (which it should given that it is backed by the eurozone's most creditworthy governments), the guarantees would not have to be called until 2022 when the first debt repayments are due.
But the figures that hit the headlines in Germany and Portugal would no doubt be the ultimate costs to taxpayers there, regardless of when they came due. This would clearly cause much unrest among voters who are either strongly opposed to the provision of bailouts or have taken their medicine in order to receive them.
Even a small cost might be politically very damaging, implying that European governments will continue to resist anything but the smallest haircuts on this debt. Accordingly, EFSF defaults might well lead to exit from the currency union.
Benefit to Greece 4/5; damage to global creditors 4/5; likelihood 4/5.
NO SILVER BULLETS
To conclude, then, the diverse nature and distribution of Greece's debts mean that there are various forms of debt restructuring and default that Greece could potentially employ in order both to reduce its near-term financing pressures and reduce its outstanding debts.
It seems likely that any forthcoming default will incorporate a number of these different elements, and perhaps some we have not considered.
But with many of the easiest options having already been employed, there are no silver bullets left for Greece and its creditors.
Accordingly, while limited forms of default might help to buy Greece some time, we doubt that the major debt writedown which will ultimately be needed to bring Greece's debts down to a sustainable level is compatible with its continued membership of the currency union.
Jonathan Loynes is chief European economist and Jennifer McKeown is senior European economist at Capital Economics.
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