Euro-zone finance ministers have finally agreed a second, €130bn bail-out plan for Greece. The bail-out package includes an agreement with private sector investors on a Greek debt-swap deal. The deal will cut the value of Greek bonds held by the private sector by 53.5% rather than the 50% agreed earlier, reducing Greece's debt burden further.
The aim is to bring Greece's public-debt-to-GDP ratio to 120% by 2020. For this purpose, euro zone leaders also agreed to lower the interest rate on the loans provided to Greece. Moreover, the profits made by the European Central Bank on its holdings of Greek government debt will be returned to Greece. Finally, the central banks of the member states will also pass on to Greece the income that they make from their holdings of Greek government bonds.
The deal is likely to ease investor concern about an imminent Greek default. Without the bail-out Greece would have faced the prospect of defaulting on a €14.5bn bond redemption due by March 20th.
However, many challenges remain. Particularly, the target of reducing Greek debt to around 120% of GDP is still optimistic. First, the target depends on the Greek government fulfilling its part of the deal by continuing to implement sharp budget cuts in the next couple of years. There is a general election likely to take place in April this year, and it is far from certain that the new government will remain committed to the bail-out conditions despite written pledges by party leaders. Opposition to fiscal austerity has been growing significantly in the country amid high unemployment (particularly youth unemployment), which will continue to fuel social unrest against austerity measures. The Greek government has already implemented deep public spending cuts and sharp tax increases, but has a record of missing targets and deadlines.
Second, the 120%-of-GDP target also depends on the Greek economy returning to growth, thus boosting tax revenues for the government and reducing social welfare payments. However, we expect the economy to remain extremely weak in 2012 and beyond (exacerbated by the deep fiscal-austerity measures), which may turn out to be the biggest obstacle to reaching the ambitious target.
- Finally, even if Greece were to achieve the 120%-of-GDP target , it is far from certain that this would constitute a sustainable level of debt. Economists regard a level of 60-80% of GDP as more suitable because it would allow debt interest payments to remain manageable.
Overall, the latest deal shows once again that Greece's international creditors focus primarily on debt repayment, highlighted also by the requirement for Greece to have a special escrow account for debt repayment and the requirement for Greece to change its constitution to prioritise debt repayment. We believe the country's ability to generate economic growth has been neglected so far, which is likely to keep Greek debt levels at unsustainable rates and may require another default (in addition to the private sector involvement), including by Greece's public lenders such as the ECB and euro zone governments.
