The effects of a Greek debt restructuring

2011-06-19

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In my previous articles I have pointed out the effects of a Greek default, however I have not yet looked into the case of a debt restructuring, which is what I shall do in this article.
Greece would have to default on its debt long ago had it not been for the bailout from the troika (IMF, EU, ECB). The troika’s money has kept the country running and has prevented (or postponed) the otherwise certain bankruptcy. Today Greece is at a crossroads, since the next payment of the bailout package is still not certain due to many reasons. Regardless of the final outcome of the current debates regarding July’s payment, the end to the Greek crisis is predetermined, as the country will not be able to avoid the inevitable in the near future, i.e. default or restructuring, since the situation in the real economy does not allow any space for optimism and does not offer any substantial proof of recovery without default. All that the troika aid does is to postpone this, as the ramifications of a failure of the safety mechanism would be catastrophic for the EU and the global economy at this stage. Greece has long now practically gone bankrupt, as it has lost the ability to loan money that is necessary to cover the state’s needs and responsibilities. At this point the country cannot survive in the bonds market, as the cost of borrowing is forbiddingly high thanks to the very high default risk the Greek bonds have. Under such conditions, when loaning money is impossible and when costs cannot be covered the natural result is default or at the very least a restructuring of the debt.

A debt restructuring is the process through which an agreement is reached between the debtor and the creditor to change the terms of the loan, since the debtor is unable to cover his/her responsibilities under the existing conditions. Some of the basic parameters of the structure of a loan are its total amount, its payment period and its interest rate. When a restructuring occurs, the period is extended, the interest rate is redefined (decreased/restructured) and the total amount is reduced (the so-called “haircut”). In other words a debt restructuring means that the creditor will lose part of the amount he/she would normally receive. Hence a debt restructuring is technically a partial default.
The logic is to minimize the loses that are inevitable. As such the scenario of a Greek debt restructuring is similar to that of a Greek default however the consequences are of a different magnitude, since it is one thing losing part of an amount and another losing the entire amount.
The key factor in the restructuring of the debt are the negotiations that will take place between Greece and its creditors to define the nature of the process. In other words to clarify who will lose what and who will gain what. The outcome can either be a “mild” restructuring which is the optimist scenario whereby the creditors and Greece will reach an agreement where a small part of the loan will be lost and the payment period together with the interest rate will be fundamentally redefined to meet the needs and the capacities of the Greek economy; Or an uncontrollable restructuring which is the worst form of restructuring as it resembles a complete default, since most of the money owned will be lost and the time period as well as the interest rate will not allow space for the country to be effective in covering its responsibilities.

In the case of a mild debt restructuring, the difference regarding the consequences will be determined over which creditor or group of creditors will lose the most. For instance if Deutsche bank, one of the main creditors, loses quite a few, then the impact on the entire of the EU can be significant, due to the size and influence of that bank on the European and global economy. On the other end, if the Cypriot banks are the ones who lose the most out of the bargaining, then the shock will be felt in the small economy of Cyprus and to some extend in Greece itself, where the Cypriot banks carry out operations, but the rest of Europe will not be affected. Of course it is not that much of a dilemma, if those two options are provided, yet the situation is far more complex than the above oversimplified examples, but the idea remains the same: The consequences are inseparably attached to the final outcome of the bargaining between Greece and its creditors. I expect a sharing of cost from all sides of the creditors and from Greece as well who will probably have to offer a number of guarantees, such as a package of new austerity measures, or even plans of reforming the tax collection mechanisms in the country, allowing privately-owned firms to collect taxes (whether that is contradicting the very essence of national sovereignty and whether it is morally , legally and politically correct is another issue). No matter the exact effects of a mild restructuring, what remains certain is that the euro and the EU as a whole, will not suffer as much from the Greek crisis and will in a sense secure the viability of the single currency and the European safety mechanisms.

A mild restructuring will not require the expulsion of Greece from the euro, which is positive for the EU as a whole (not necessarily for Greece though), since if the opposite was to be held true then the single European currency could be disintegrated by a chain effect in the entire European periphery. The impact of the restructuring will be felt by the creditors and to a lesser extent by those who are connected to them, but it can be withstood, meaning that no domino effect will be caused anyhow, which is what everyone in Europe really fears. In that sense a mild restructuring is the most prudent choice, but of course it requires compromising sentiments from all sides which is not easy to get. Nevertheless should a mild restructuring of the Greek debt be agreed upon,the viability of the EU or its constituent local economies will not be threatened anyhow by the volatility of the Greek economy as the situation will be put under control.

Regarding the worst scenario, that of an uncontrollable debt restructuring, the consequences are certainly much worse. All creditors will lose most of their money, but most importantly a clear message will be sent to the markets that Greece is defaulting and that the troika bailout package is not effective, thus raising further doubts for the other countries that are also receiving aid, Ireland and Portugal.
An uncontrollable restructuring of the Greek debt will pretty much have the same effects of a Greek default as the expectations in the market will remain very negative regarding the final outcome of the process and the investors will be extremely cautious in putting their money in Greece or elsewhere in the European periphery. An uncontrollable debt restructuring can be the first stage of a complete default with all the catastrophic ramifications this will have on the euro, the credibility of the bailout packages and the EU itself. This could well lead to the disintegration of the single European currency, but could also jeopardize the efforts to save Ireland and Portugal from the same fate. Such a case could be the final blow to the already shaking EU architecture. All we can hope for is that should a debt restructuring occur, that be a mild one, for the benefit of Greece and the EU as a whole.</div>