On 27 November, the Eurogroup (the finance ministers of the 17 countries that use the euro) and the IMF reached an agreement to reduce Greece's public debt to below 110% of GDP by 2022 and to ensure its repayment. The compromise avoids the need for a haircut on Greek debt held by eurozone governments in the short term. However, the deal, if implemented successfully, exhausts most options available to reduce Greek debt other than an outright write-down of Greek government debt. In the medium term, eurozone leaders are still likely to face the prospect of having to accept a haircut on their loans to Greece if they want to prevent Greece from defaulting and leaving the euro area.
The deal's details
The deal provides significant debt relief to Greece, particularly through: lowering interest rates on concessional loans made under the bail-out programme; extending maturities on bilateral and EFSF loans by 15 years (the EFSF is the eurozone's temporary bail-out fund); and transferring to Greece profits on Greek government bonds made by the European Central Bank (ECB).
The government is expected to use the ECB profit rebate (estimated at around €11billion) to buy back at a discount (no higher than the closing price of 23 November) Greek government bonds traded in the open market and to cancel them. The buy-back could happen no later than 12 December, just before the next Eurogroup meeting on 13 December.
If all this is achieved, the Eurogroup expects aggregate debt to be stabilised at approximately 175% of GDP by 2016 (from around 177% of GDP estimated for 2012); to be reduced to 124% of GDP by 2020; and to be "substantially below" 110% of GDP by 2022.
Lending to Greece is set to resume
The agreement by Eurogroup and IMF leaders is still dependent on ratification by eurozone parliaments. It is likely to be approved, but ratification is not a foregone conclusion. On the assumption that the deal is ratified, the EU/IMF will resume concessional lending under the €240bn bail-out programme (of which €148.6bn has been disbursed so far) in the short term, including three tranches totalling €43.7bn that have been suspended since June. By December 13th, €34.4bn will be released--€23.8bn in EFSF bonds for recapitalisation of Greek commercial banks and €10.6bn for budgetary financing. The €9.3bn balance of the suspended loans will be released in instalments during the first quarter of 2013. This will inject liquidity into the depressed economy, which has contracted by almost 20% since its pre-crisis peak in 2007; we expect the economy only to start growing from 2015 at the earliest.
The compromise avoids a haircut on Greek debt held by eurozone leaders in the short term. A haircut by official lenders (so-called official sector involvement or OSI) - on top of the haircut already accepted by private-sector bondholders of Greek debt in March this year (so-called private-sector involvement or PSI) - would have been politically unacceptable in many creditor countries, especially Germany, which faces a general election next September. However, the target to reduce Greek public debt to below 110% of GDP by 2022 is again so ambitious that OSI is still likely in the medium term, by 2020 at the latest but probably well before that time (albeit after the German election in 2013). The 27 November deal, if implemented successfully, exhausts most options available to reduce Greek debt other than an outright write-down of Greek government debt.
Major economic and political risks remain
In addition to delaying the official haircut on Greek debt, the new plan contains other elements that could undermine the lenders' targets. In particular, the debt buy-back plan may not succeed if private-sector bondholders of Greek debt (which already suffered a write-down of over 50% of the face value of their bonds in the PSI process) do not accept the terms of the buy-back scheme. As long as the results of the buy-back are unclear, the IMF will not decide on disbursing almost €5billion of IMF loans still outstanding to Greece in 2012.
Moreover, there is a high risk that Greece's economy will continue to contract sharply in the short term (as our forecasts show), which means that even the new targets for Greece's public debt/GDP ratio are unlikely to be met given lower-than-expected GDP; nominal GDP is the denominator in the public debt/GDP ratio, so that a lower GDP value automatically means a higher debt/GDP ratio.
Meanwhile, although the agreement buys time for the fragile three-party coalition government, it also places it under considerable political stress. Already Antonis Manitakis, the minister of administrative reform affiliated to the Democratic Left (DIMAR) - one of the two left-wing junior coalition partners in the fragile three-party coalition - has said that he will not implement agreed measures on reducing public-sector staff numbers by 27,000 by the end of next year. Moreover, Evangelos Venizelos, the leader of the Panhellenic Socialist Movement (Pasok) - the second left-wing junior coalition party - is likely to face a challenge to his leadership at a party congress to be held next February for supporting the stringent reforms. Finally, the prime minister, Antonis Samaras of the centre-right New Democracy (ND), the senior coalition party, is reportedly planning to reshuffle his cabinet as soon as lending to Greece resumes. Against this backdrop and amid the ongoing threat of major social unrest, there is a high risk of disruptive early elections by 2014 that could undermine programme implementation even further.