Courtesy of Mish.
Greece’s “Meaningless” Debt
The Debt-to-GDP ratio in Greece is now at 175% and rising. Recall Troika statements said anything over 120% was unsustainable.
Yet each quarter debt and debt service ratios rise. Now, a new argument has arisen: Greece does not need debt relief because its maturities and payback time are large.
Charles Wyplosz, a professor of economics at the Graduate Institute of International and Development Studies in Geneva, takes issue with that belief in a Bloomberg article The Anti-Debt-Relief Crowd Is Wrong on Greece.
Since Chancellor Angela Merkel’s impressive victory at the polls, however, a push-back has begun, most recently from Klaus Regling, the managing director of Europe’s bailout fund, the European Stability Mechanism. He argued in an interview last week that by now the maturities on Greek debt are so long and the interest rate it pays so low that the scale of the debt pile itself has become “meaningless.”
This is a new and more sophisticated twist to the usual argument against debt relief, which is that forgiveness risks encouraging chronically undisciplined countries to again run up their budget deficits, safe in the knowledge that whenever debts get out of control they won’t have to pay. Both the old and the new arguments are wrong and fraught with risk.
Greek DepressionThe expectation that debt relief should follow the German elections was based on a number of immovable facts. The first is that Greece is in the grip of an economic depression that has lasted six years, wiping out 30 percent of its gross domestic product — the same contraction the U.S. suffered during the Great Depression. Greece is bleeding profusely. The second fact is that after four years of austerity measures designed to reduce Greece’s public debt, it has instead continued to grow to 175 percent of GDP. This is despite the 2012 restructuring of bonds held by the private investors, which shaved 30 percent of GDP worth of debt from what Greece owes.
Regling said in his interview that Greece already enjoys concessional interest rates and long maturities on its debt that amount to a form of relief — and this is true. Last year, the average maturity of Greek debt was extended from about six years to 16 years, as a combined result of the private sector restructuring and new loans from the ESM. The annual interest rate that Greece has to pay on these new loans is low, about 3 percent.
Yet whether Greece can pay the interest on its loans for now is not the issue. Until Greece’s nominal GDP growth, currently sharply negative, rises above the interest rate it pays on its debts, these will go on increasing as a proportion of the economy. This is simple arithmetic: Debt service costs add to the debt, the numerator, faster than GDP, the denominator, rises.
It is true that debt relief could prove contagious, but the answer to this objection is: “Yes, and so it should.” Greece is not the only euro area economy saddled by an unsustainable public debt.
Greece needs a debt relief package soon or its only option will be inflation, which means leaving the euro area. Even if this is a pessimistic view, it is a very real risk. Merkel must now weigh that risk against the political cost of reversing herself.
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