Will a haircut help Greece’s debt crisis?

6th February 2012

The 70% haircut would work by "cutting the bonds' face value in half, reducing the average interest rate to less than 4 percent and pushing repayment of the bonds decades into the future."

It is hard to find any economist who believes that this will work to make Greece's debt burden sustainable. Keith Wade, chief economist at Schroders, gave his verdict on Bloomberg Televison: "This won't be the end of the story…Greece has a lot of debt with the public sector as well – the IMF, the ECB. None of this is touched by this deal. It would still have a very high debt to GDP ratio even if wrote off its private debt."

Mindful Money blogger Shaun Richards agrees, writing in his blog last week: "Its impact on Greece's national debt is too small to be of significant influence. In something which is both an irony and an example of a complete lack of long-term planning this is partly caused by the holdings of the European Central Bank which holds approximately 45 billion Euros of Greek government bonds."

Richards says that as a result there is more and more talk about the possibility of the European Central Bank taking a haircut on its holdings. He suggests that the ECB has been universally averse to such a deal. Wade sees more chance of compromise: "The ECB probably would take a haircut. They bought into Greek debt at relatively low prices and may be sitting on profits. As such they may be willing to accept some restructuring of the debt."

The problem for Greece is that any restructuring of its public debt will require more progress from the Government on fiscal targets. At the moment, it has barely hit any of these targets. Its GDP is falling and it is in its fourth year of recession. As Wade points out, policymakers are unlikely to be able to stabilise the economy in this environment.

Wade's view is that the Eurozone needs to formulate a growth plan. Until a coherent growth plan is in place, all debt reduction strategies are likely to be ineffective. Eurozone policymakers at least appear to recognise this: Herman Van Rompuy, the president of the European Council is quoted in this piece: "Last year European leaders had to take difficult and sometimes painful measures to stabilise the Eurozone, but as you all know, this was necessary – and we start seeing now that it was worth the effort…Yet we recognise that financial stability is in itself not enough to get out of the economic crisis. We must do more, in particular on economic growth and employment." He goes on to say that creating jobs for young people, helping small- and medium-sized enterprises to get credit and deepening the single market could all help to drive growth.

However, their efforts to date have been met with widespread scepticism: Sony Kapoor, the managing director of Re-Define, the think tank said: "The Council's presentation of a strategy for growth is a strategy in name only being far too narrow in scope, too vague in commitments and too small in ambitions to have much impact." Certainly, if any initiatives are in place, they are not having the desired effect with much of the Eurozone likely to fall into recession this year.

Equally, any improvement in growth may come too late. Wade says: "Growth pacts can take years to work through the system. The market simply doesn't have that time."

Even Eurozone policymakers are aware that Greek's debt levels are unsustainable and it must default. The question is whether it is ‘orderly' and can be passed off as restructuring. This is looking less and less likely as each attempt to restructure is met with another obstacle. Ultimately Greek's debt is too big to generate growth and without growth it cannot pay its debt. 


More from Mindful Money:

Growth is essential to rescue the Euro – the question is, how?

Hungary could prove more damaging to the Eurozone than Greece

Is austerity working in Ireland?

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