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May 2011
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Greeces sovereign debt crisis is once again taking
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centre stage. Several options are under discussion to
publications. provide further support for Greece, including a new
aid package, an updated set of fiscal measures and a
debt restructuring programme. Although the situation
is still evolving, we take a look at what solutions
may be feasible. In addition, we try to establish what
effect a debt restructuring may have on the European
and global economy.
Eurozone finance ministers are evaluating whether to expand the aid package to a
maximum of EUR 170 billion. Meanwhile, a more effective privatisation programme,
announced by the Greek government, could help improve the situation. Expected
inflows are estimated to be EUR 50 billion including real estate disposals, with an
estimated 20% reduction to the debt-to-GDP ratio by 2015. The target is to provide
Author enough funding so that Greece has no need to return to the market for finance in
2012 or 2013, thereby enabling the Greek government to concentrate on the reforms
and structural adjustments that are needed to return to a sustainable debt path.
Debt Restructuring
Sovereign debt restructuring implies swapping outstanding bonds with new
Maria Paola Toschi
Vice President
instruments with a prolonged maturity and/or a reduced interest rate level. This
Market Strategist, Milan could mean a reduction in the value of the bonds already placed on the market
maria.p.toschi@jpmorgan.com (known as a haircut). The agreed financing obtained from the EU and the IMF has
already implied an average duration extension, which could still be prolonged.
Greece: Restoring the Economy
Exhibit 1: Ten-year bond interest rates spread of peripheral countries versus German Bunds
1,000
600
400
200
0
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
Source: Bloomberg, J.P. Morgan Asset Management. Data as of May 10, 2011.
Meanwhile, the average floating interest rate is already very The Economy at a Glance
low compared to the market level.
The Greek crisis became evident when the Greek government
A debt restructuring would involve a substantial haircut for announced a deficit-to-GDP level of 15.4% for 2009 and a debt-
institutional and private investors who hold Greek bonds. The to-GDP level of 127.1%. In May 2010, the EU and the IMF put
European financial sector could be penalised by losses on bond together a EUR 110 billion aid package to support Greece, to be
portfolios. According to data from the Bank for International distributed over three years. The aid was dependent on an
Settlements (BIS), German and French banks, together with ambitious set of structural fiscal austerity measures in order to
Hellenic banks, are most exposed. In addition, in the case of make the Greek public finances sustainable and the Greek
default for some Greek banks that are overly exposed to economy more competitive. The idea was to put the country in
government bonds, there could be an additional indirect a position to return to the financial markets in 2012.
contagion effect due to the presence of Hellenic bank bonds in
Low competitiveness, the absence of economic growth, and
the portfolios of many European financial institutions.
growing social unrest have meant that the Greek government
Losses or write-offs on bank portfolios would potentially lead has only met part of the economic and fiscal plan. At the end
to a more fragile financial system, further recapitalisation of 2010 the deficit-to-GDP ratio decreased to 10.5%, but was
needs and have an unfavourable impact on credit growth. A still well above the 8% target, and the debt-to-GDP ratio
restructuring may also hurt individual bond holders and could increased to 142.8%. Despite numerous efforts, fiscal
lead to a reduced propensity to underwrite new government dynamics do not support an efficient de-leveraging path and
issues. This would be particularly challenging due to the the debt-to-GDP level is expected to increase to 160% in the
recent increase in issuance and current financing needs coming years, mainly because of a very high primary deficit.
related to the huge amount of debt at the European level. According to recent EU analysis,1 the implementation of the
fiscal plan has been slower than forecast and the 2011 deficit-
In terms of the extent of any restructuring we must distinguish
to-GDP target of 7.6% is proving very difficult to achieve. The
between preemptive and post-default cases. In the former
actual 2011 deficit-to-GDP could be close to 9.5%. Additional
situation, the negative impact on bond values is limited, while
fiscal measures are necessary, which are expected to focus
in the latter, the haircut, and therefore the global impact, is
mainly on improving tax collection.
much greater. A feasible way out from the Greek crisis could
be through additional aid, privatisations and a soft The Greek economy remains fragile. In 2010, GDP decreased by
restructuring. A preemptive restructuring would be feasible 4.5% and is expected to decline by a further 3% in 2011 (IMF
because Greek bond prices are already discounting such an estimates). In February 2011, unemployment reached 15% and
eventuality. We do not believe the market rumors about industrial production continued to decline. There are reasons to
Greeces exit from the Monetary Union as this would have be positive, with the booming German economy (Greeces main
extremely negative implications on the euro project and euro
credibility. The main challenge for Greece will be to find a way 1
The economic adjustment programme for Greece, Third Review, Feb 2011.
to stimulate production and innovation in order to put the
economy on a path of sustainable development.
80
pension funds, 19% by French banks, 12% by German banks
60
and 4% by U.K. banks, while other European banks had limited
40
exposure (Exhibit 2). Public institutions have already
20
underwritten 38% of the total debt, limiting contagion risk to
0
private investors. In this context the main risks of a debt Greek Greek EU/ French German U.K. Portu- Italian Other
banks PF* IMF* banks banks banks guese banks
restructuring and consequent haircut to the value of Greek banks
bonds are related to: Source: BIS. Data as of September 30, 2010.
* Greek PF means Pension Funds. EU/IMF also includes ECB and World Bank.
2,3
The economic adjustment programme for Greece, Third Review, Feb 2011.
According to IMF analysis, the majority of cases of preemptive Uruguay 2003 92.5 8 48.3 49.3
Dominican
sovereign debt restructuring were based on maturity Republic 2005 54.1 1 7.0 14.3
extension and had a limited haircut effect. This is true
Post default
especially when the event is already expected by the markets,
Ecuador 2000 47.2 25 49.4 45.0
and when bond market prices are already discounting losses, Russia 2000 21.7 44 23.7 39.3
as with Greek bonds. Argentina 2005 129.4 75 59.7 53.1
The systemic impact can also be very different depending on Source: Cross-Country Experience with Restructuring of Sovereign Debt and
Restoring Debt Sustainability, IMF, August 29, 2006.
the ratio of sovereign debt underwritten by foreign or
* Note: mainly IMF estimates.
domestic investors, and/or by institutional or private investors.
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