Satyajit Das: Athens sub-plots give pointers to future for weaker European nations

Midweek View: With Greece increasingly doomed, no one buys the oft-stated European leaders' view its position is unique or exceptional
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The Independent Online

The Greek prime minister spoke of a choice between "austerity" and "disorder". lucas Papademos got both; the Greek parliament passed the European Union-dictated severe budget cuts and outside rioters protested the plan. In great dramas, sub-plots support the main story. The story of "hair-shirts" (the Greek economic plan) and "haircuts" (the writedowns of Greek debt or PSI, private-sector involvement) is little more than an intriguing sideshow in the broader European debt crisis.

With Greece increasingly doomed, the real significance of the negotiations is that they provide a template for future European sovereign restructurings. No one buys the oft-stated European leaders' view that Greece's position is unique or exceptional, with Portugal increasingly likely to be the first in the line of fire.

The troika – the EU, European Central Bank and International Monetary Fund – needs to reduce the level of Greek debt to a "sustainable" 120 per cent of gross domestic product by 2020. The bond deal and the latest budget cuts are designed to achieve this, paving the way for a second financing package for Greece to enable it to repay a €14.5bn (£12.1bn) bond on 20 March 2012. Deterioration in Greece's finances required the bigger writedowns and greater budget cuts. In the end even with considerable tweaking and generous assumptions, the number, which nobody believes, was an irrelevant 120.5 per cent.

The plan will entail bondholders suffering losses of 70 per cent to 75 per cent in a "voluntary" restructuring. But the agreement reached may not be implemented. The Institute of International Finance, negotiating on behalf of private lenders, represents only around 50 per cent of banks and investors. The deep losses will increase resistance to the deal, especially from hedge funds who may prefer to take their chances in a default. One option is to insert collective action clauses (CACs) into existing bond contracts, allowing a supermajority of lenders to bind the minority.

A complicating factor is that the ECB refuses to take losses. With direct holdings of Greek bonds of €40bn as well as additional loans to banks secured over Greek bonds, the ECB's capital of €5bn (scheduled to increase to €10bn) is insufficient to absorb losses. As the CAC would force the ECB to share in losses, a special arrangement will exempt it from the effects of any CAC, to the further detriment of resistant private lenders.

If the new agreement cannot be implemented, then the troika could extend the necessary money to meet the March maturity and continue negotiations. Alternatively, they could arrange an "orderly" default of Greece. The worst outcome is that Greece unilaterally declares a debt moratorium and leaves the euro. This agreement is unlikely to be final. Despite government measures, debt increases. According to the EU statistics office, Greece's debt reached 159.1 per cent of GDP in the third quarter of 2011, up from 138.8 per cent a year earlier and 154.7 per cent in the previous quarter.

Greece may get through the March 2012 maturity but the arbitrary 120 per cent debt-to-GDP ratio, the best case under the plan, is unsustainable, even in the unlikely case that it is met. The Greek economy, which has been in recession for about five years shrank by 7 per cent in the later part of 2011. Budget revenues for January 2012 fell 7 per cent from the same time last year, off €1bn. This compares with a budget target for an 8.9 per cent annual increase. Value added tax receipts decreased by 18.7 per cent in the same period compared with January 2011.

Greece's financial position will deteriorate and it will miss key milestones – debt levels, budget deficits, asset sales and structural reforms. With elections due in April 2012, government support for the austerity plan cannot be assumed. History suggests that a writedown of debt for distressed borrowers is frequently followed by others. In the end, Greece may just live to default another day.

Sub-plots connect main plots in thematic terms or provide minor diversions or comic relief. The light relief in this instance comes from a group of hedge funds who have threatened to take action in the European Court of Human Rights alleging that Greece has violated bondholders' "rights".

Whatever Greece's fate, European government debt is likely to be significantly re-rated. It means impaired market access for weaker nations and higher credit costs, which will compound the global debt problems. Other embattled European nations will be scrutinising the Athenian sub-plot closely as to clues for their own future.

Satyajit Das is the author of 'Extreme Money: The Masters of the Universe and the Cult of Risk' (2011)