Download Greece: « extend and pretend » will probably not be the end

Aperiodic – n°15/11 – February 6, 2015
Greece: « extend and pretend » will probably
not be the end
4%
2%
0%
-2%
-4%
9/14
12/14
6/14
3/14
9/13
12/13
6/13
3/13
12/12
-6%
9/12
 Our central scenario is highly vulnerable
to a negative growth shock with a strong
risk for debt sustainability. Then, the
‘extend and pretend’ strategy would make
sense only if it buys time for a more
constructive solution.
6%
6/12
 Fiscal easing should, in our view, increase
rather than jeopardise the success of the
Greek adjustment program by providing a
reflationary impulse to the economy and
finally improving debt sustainability.
ECB and ELA funding
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
3/12
 The compromise should probably be a mix
of maturity extension, more concessional
rates, fiscal easing and structural reforms.
from €44.9bn in November (14.1% of total
liabilities). Funding needs due this year are
significant, especially in Q315 when ECB bondholding repayments are due (€3.5bn in July and
€3.2bn in August).
12/11
 In spite of mounting pressure we believe
that an agreement between Greece and its
creditor countries will be achieved and we
look at a ‘Grexit’ as a tail risk.
domestic deposits MoM (rhs)
ECB and ELA, % of total liabilities
Where we stand: a tight calendar
The new Greek government has started its
rounds of negotiations with EMU partners and
the Troika. The calendar is tight given the
country’s bailout program expires at the end of
this month. Pressure came from the ECB
announcement that it is refusing to continue
allowing Greek banks to use Greek government
debt as collateral for ECB funding from
11 February (when emergency talks are
scheduled with Eurozone finance ministers). Recall
that Greek banks have faced large deposit
outflows since December due to political
uncertainties. According to monthly data released
by the Bank of Greece, domestic deposits by
households
and
non-financial
corporations
decreased by €3bn in December 2014 (-1.3%
YoY). Banks are largely dependent on ECB
funding, which reached €56bn in December 2014
Group Economic Research
http://economic-research.credit-agricole.com/
Source : Bank of Greece
What to expect?
As we mentioned in our previous publication
Greece: political uncertainties and public debt
renegotiation ahead, we exclude the scenario of
a Grexit given the financial and political
implications at stake for Greece and EMU partners.
Our baseline scenario is that an agreement will
eventually be found with a different mix of
maturity extension, rate cuts and fiscal easing
possible. Luckily, common ground with the Troika
can be found more easily in structural reforms and
the fight against tax evasion.
A few options have been proposed by academics
that could reduce debt-servicing costs:
Paola MONPERRUS- VERONI
Nina DELHOMME
[email protected]
[email protected]
 As was already done in 2012, the Greek Loan
Facility could be extended further by 10 years
to 2051 (for an initial maturity of 2026).
 In addition, the interest rate on the Greek
Loan Facility could be reduced again (the
initial 400bp spread was cut in 2011 and
again in 2012). It is now 50bp above 3M
Euribor. Such an option could prove to be in
conflict with article 122 of the TFEU defining
the conditions for a loan to qualify as financial
assistance.
Box 2: Article 123 of the Treaty on the Functioning
of the European Union (TFEU)
Article 123 of the TFEU forbids the ECB and member
states National Central Banks to grant any type of
lending to public authorities of a Member State or to
directly acquire any type of debt instruments from them.
 Exchanging EFSF and bilateral loans for
GDP-indexed bonds. Indexing the notional
amount of official loans to Greek GDP (by
setting a benchmark level) would reduce the
sensitivity of the debt trajectory to shocks on
growth. Such a device would allow for sharing
the costs of lower growth (more debt for lenders
and more deficit for borrowers). It would also
allow for sharing the responsibility for program
failure due to an unrealistic hypothesis.
Box 1: Article 122 of the Treaty on the Functioning
of the European Union (TFEU)
Article 122 of the TFEU allows for the possibility for the
European Union or a Member State to grant financial
assistance to another Member State under exceptional
circumstances. Such an assistance taking the form of a
loan has to bear an appropriate interest rate in order to
exclude a bail-out of the Member State liabilities. Such
an interest rate should be high enough to cover risks
and ensure fiscal discipline.
 Reducing the projected primary surplus to
1.0-1.5% of GDP under a reform plan (to be
detailed at the end of this month) with tackling
tax evasion a priority.
 Raising the present €15bn cap on the
issuance of T-bills to €25bn in order to
cover funding needs for the time an
agreement is reached with the Troika.
 The maturity of the EFSF loans could also
be extended (average maturity is over 30
years).
Such proposals have been put forth by Darvas and
Hüttl1, who calculated the combined effect of the
three measures as a reduction in the net present
value of Greek debt amounting to 17% of 2015 GDP.
A
solution
unsustainability?
Mr Varoufakis’ proposal
Whatever solution to debt reprofiling is chosen,
the problem of sustainability will not be
addressed.
The new Greek Finance Minister, Yanis
Varoufakis, has adopted a more conciliatory tone
after rather alarming statements last week. On
Monday 2 February, abandoning the suggestion of
a haircut, he laid down his proposal:
 Transforming the liabilities held by the
ECB and the national central banks of the
Eurosystem (under the SMP program) into
perpetual bonds. As such, the proposal – a
sort of rollover – seems incompatible with
article 123 of the Treaty on the Functioning of
the European Union, which does not allow for
the monetary financing of sovereign debt. The
Greek government could then envisage a new
ESM program used for ECB-held bond
repayments. In order to compensate for the
profit losses coming from retroceded interest
payments, a longer maturity of the new ESM
loan should be envisaged. Similarly, an ESM
loan could be used to repay a higher interestcarrying IMF loan with a benefit in terms of
debt servicing.
1
Z. Darvas and P. Hüttl: “How to reduce the Greek debt
th
burden”, 9 January 2015, Bruegel blog.
N°15/11 – February 6, 2015
to
debt
Sustainability is merely a political issue. It depends
on how much the country is paying to service its debt
and on the size of the primary surplus it has to
ensure in order to decrease debt at an acceptable
pace. Debt-servicing for Greece has been made
acceptable by the concessional conditions on
loans of the Greek Loan Facility (50bp above the
Euribor) and by the EFSF (100bp above EFSF
borrowing costs). In accrual accounting terms,
interest payments amount to 4.3% of GDP in 2014
but, if we take into account the ten-year deferral of
interest payments to the EFSF as well as the
retroceded profits on Greek bond purchases within
the SMP, effective interest payments amount to
around 2% of GDP2. The implicit interest rate
2
The country has already benefited from a reduction in interest
charges and extended maturities. In fact, the lending rate on the
first program Greek Loan Facility was reduced. The initial
interest rate was linked to the 3M Euribor with a 300bp spread
during the first three years then 400bp thereafter: it was cut to a
spread of 150bp in 2011 and again in 2012 to 50bp. Besides,
an extension of the maturity by 15 years to 2041 (from 2026
initially) was decided. Also, profits made by the ECB and
national central banks on their Greek bond holdings (about
€27bn) have been passed on to Greece since 2012. EFSF
interest charges have also been deferred by 10 years.
2
Paola MONPERRUS- VERONI
Nina DELHOMME
[email protected]
[email protected]
(interest payments as percentage of total debt) was
2.4% in 2014. The umbrella of OMT and QE
announcements has ensured that such
conditions can be locked-in in the medium term,
if Greece respects its commitments. The pace of
debt reduction of course has to satisfy creditors but
also citizens. However, it is a political decision to
decide which size of primary surplus is
acceptable and how to allocate it between
expenditure and revenues. Manifestly, the
political outcome in recent Greek elections has
confirmed that the pace of adjustment agreed
with the Troika is no longer acceptable.
Under the fifth review of the Extended Fund
Facility, the target of a primary surplus of 1.5% of
GDP in 2014 and of 3% in 2015 was set. From
2016, the IMF projections were based on a primary
surplus of 4.5% of GDP till 2017 declining to 4.2%
thereafter and till 2020. Under such conditions and
under a rather optimistic projection of GDP growth
at a yearly average rate of 3% from 2015, the debtto-GDP ratio would have reached 117.2% in 2022.
Such an adjustment path implies a positive fiscal
impulse of 1.2 points of GDP on average from
2015 to 2022. The overall budget deficit stabilises
around the equilibrium and a positive growth–
interest rate differential contributes to 20% of the
debt-reduction effort. Under this scenario the
negative output gap is completely resorbed by
2017 and the debt reduction is accompanied by a
pro-cyclical fiscal stance (accommodative).
Greece : debt reduction proposals
% of GDP
200
180
160
140
120
100
80
IMF negotiated scenario
Lower primary surplus
Extended maturity and lower rates
Sources : IMF, Crédit Agricole S.A.
Among the proposals of Mr Varoufakis, the one
to reduce the 4.5% IMF-projected primary
surplus to 1.0-1.5% is probably the most
interesting and full of consequences. Projecting
a 1.5% primary surplus from 2015 and starting
from a better-than-anticipated budgetary execution
in 2014 with a primary surplus at 2.7% (European
Commission, autumn forecast), the debt-to-GDP
ratio can be reduced to 126% in 2022. The yearly
average fiscal impulse would increase to 2 points
of GDP on the 2015-22 period.
N°15/11 – February 6, 2015
Such a solution looks like quite a reasonable
way out, providing Greece with a more
accommodative
fiscal
stance
without
jeopardising the debt-reduction objective. Such
a positive fiscal impulse could increase the
probability of reaching the initially too optimistic
GDP projections. After all, the initial 117% level for
the debt target was an arbitrary one. The ‘moral
hazard’ problem linked to the easing of the fiscal
stance should not be overestimated as the country
will still be committed to producing a primary
surplus and reducing its debt level under the Troika
(or an eventually ‘revised’ Troika) assessment.
Attached to such a debt-reduction path is a
sustainability risk, however, as was the case with
the IMF-negotiated path. But that risk is, in our
view, reduced rather than increased by the more
growth-friendly stance.
We simulate (see annex) the impact of both a
lower growth rate (-2 points) and a higher
interest rate (200bp) on the debt projections
according to Mr Varoufakis’ proposal of a 1.5%
primary surplus (our central scenario). We consider
an interest rate shock on the interbank rates, but
no major shock on risk premia as we remain in the
framework of a new Memorandum, which could
benefit from OMT and QE support. We consider a
growth shock as a weak-growth hypothesis of a
GDP growth rate of 1% on average till 2022.
Under the most adverse scenario, combining
lower growth and higher rates, debt remains at
unsustainable levels (167% in 2022).
That means that the ‘extend and pretend’ strategy
– whether based on reprofiling or on allowing for
more budgetary leeway – is a risky one. If the
central scenario is realised, then there is a
chance for Greece. Otherwise, the ‘extend and
pretend’ strategy makes sense only if it is
buying time for a more constructive solution.
There are not thousands of options: either a haircut
or a Eurozone-wide strategy whereby a
significantly higher growth rate is targeted and
supported by an expansionary stance whose
budgetary cost is shared (a sort of swap of bad
past debt for good future debt). This second option
would of course require mutualising future debt flows
and would be a clear step towards a fiscal union.
The first option of a haircut would also require
mutualising past debt, but would more probably
end up in a loosening of the links among
Eurozone member countries, with a postrestructuring restatement of the no-bailout
principle
and
eventually
the
common
surveillance of public finances delegated to
markets in the form of sovereign contingent
contracts that specify debt restructuring at pre-agreed
levels of distress. 
3
Paola MONPERRUS- VERONI
Nina DELHOMME
[email protected]
[email protected]
Annex:
Greece
Baseline Rate
Baseline Growth
High Growth
Low Growth
High Rate
Low Rate
210
210
210
190
190
190
170
170
170
150
150
150
130
130
110
110
90
90
70
70
50
2005
50
2005
210
190
170
150
130
110
90
70
50
2005
210
190
170
150
130
110
90
70
50
2005
2015
2025
130
110
90
70
2015
2025
50
2005
2015
2025
2015
2025
210
210
190
190
170
170
150
150
130
110
90
2015
2015
2025
2025
70
50
2005
130
110
90
70
2015
2025
50
2005
210
210
190
190
170
170
150
150
130
130
110
110
90
90
70
70
50
2005
2015
2025
50
2005
2015
2025
NB : Baseline scenario characterised by a primary surplus at 1.5% from 2015, average yearly real GDP growth rate at
3%, average implicit interest rate at 2.8%. Alternative scenarios with a shock of higher (+2%)/ lower (-2%) GDP growth
rate and of higher (+200bp)/lower (-200bp) interest rates.
N°15/11 – February 6, 2015
4
Paola MONPERRUS- VERONI
Nina DELHOMME
[email protected]
[email protected]
Crédit Agricole S.A. — Group Economic Research
12 place des Etats Unis – 92127 Montrouge Cedex
Publication Manager: Isabelle Job-Bazille - Chief Editor: Jean-Louis Martin
Information center: Dominique Petit - Statistics: Robin Mourier
Sub-editor: Véronique Champion-Faure
Contact: [email protected]
Access and subscribe to our free online publications:
Website: http://economic-research.credit-agricole.com
iPad: Etudes ECO application available in App store platform
Androïd: Etudes ECO application available in App store platform
This publication reflects the opinion of Crédit Agricole S.A. on the date of publication, unless otherwise specif ied (in the case of outside
contributors). Such opinion is subject to change without notice. This publication is provided for informational purposes only . The information
and analyses contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crédit Agricole S.A. and its affiliates
shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crédit
Agricole does not warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based,
although such sources of information are considered reliable. Crédit Agricole S.A. or its affiliates therefore shall not be responsible in any
manner for direct, indirect, special or consequential damages, however caused, arising from the disclosure or use of the information
contained in this publication.
N°15/11 – February 6, 2015
5