Is the Greek Debt Sustainable?

27 February 2015 | Philip Ammerman

Sustainability of public debt is a function of several factors. Each factor is important in different ways and at different points in time. A brief review of different factors used by financial and strategic investors to judge sustainability, and how these are interpreted in the case of Greece, is provided below. All data used reflects the situation on 12 February 2015.

Annual Interest Rate. The annual interest paid by the government to service the public debt. In 2014, the interest cost was € 5.7 billion from total central government expenditure of € 56 billion, or just over 10%. This is in line with similar ratios in many other OECD countries.
Market expectations of future interest rates. If Greece were in an inflationary environment, where interest rates are increasing, or if it were in a situation where perceived risk was making debt more expensive, then this would contribute to short-term debt unsustainability (while potentially making long-term debt more sustainable via inflation). Greece is an EU Member State, and as such is in a broadly deflationary market environment, and could capitalise on this further if it could interact more broadly with the European Central Bank. The ECB has announced it will engage in a third round of quantitative easing, in which it will purchase debt (directly and via secondary sources), and has also provided a repo interest rate of 0.05%. This low interest rate has also been effective in European Financial Stability Fund (EFSF) lending, which has been able to raise capital at an average Euribor rate of about 0.3%, with a 0.4% margin: EFSF is lending to Greece at about 0.7% interest rate. So a signal benefit of the previous two bailouts was to replace nearly 80% of total debt load which used to be privately-held, with public sector-backed debts, and higher interest rates with broadly lower interest rates.
Principal payments. In addition to interest, Greece needs to pay the original loan principal. In September 2014, Greece owed a total principal of EUR 321.7 billion. Greece does not have significant principal repayments to make in 2015, apart from an ECB bond and certain IMF payments. However, the ECB bond was expected to be refinanced by the ECB itself, while the IMF is also still in the process of disbursing loans from the previous bail-out. The situation changes in 2016-2017, when additional principal payments have to be made, but these were also partially provisioned for under the ECCL loan agreement which was being negotiated by the previous government.
Debt maturity/ies, or the number of years before the loan term expires. The longer the debt maturity, the lower the annual instalments (and the higher the accumulated interest). On the EFSF loan component, Greece has very long maturities, with roll-overs beyond 2040. On the IMF and private sector debt, loan maturities are shorter, and will need to be refinanced.
Refinancing possibilities. No country is expected to pay off 100% of its debt. Instead, countries are expected to refinance their debts, i.e. to gradually pay down the principal, and simply raise new debt to replace old debt when the old debt expires. This is a rational economic decision, and the low interest rates today make this an ideal time to be refinancing.
Economic growth potential. A creditor will judge debt sustainability by the ability of a country of grow. We assume that as a country grows, and its government eliminates deficits and incurs surpluses, it will be able to service the principal and interest on its debt, as well as invest in social benefits or other forms of public expenditure. Although the 2014 GDP numbers do show an increase with further increases forecast in 2015-2016, there is no clear growth strategy backed by the public sector.
Legal stability and rule of law. Greece is not a legally- or politically-stable country. On the one hand, the laws are constantly changing. On the other hand, the laws and public sector are so complex that even professionals in specific sectors often do not clearly understand what is happening. As a result, the public sector has become a major source of corruption. There is also no recourse via the courts: very long delays, an absence of experience in forensic investigation and a very poor quality of jurors and judges make seeking legal recourse nearly impossible, or very expensive and time consuming.
Investment attractiveness. A key driver of growth is a country’s ability to attract foreign and domestic investment. Greece has not done so. It has not liberalised key sectors. It has confusing and overwhelming bureaucracy which requires direct interaction with the public sector in nearly every area of economic life. Its public sector is a disaster in every respect in terms of productivity, citizen-friendliness, clear regulations, regulatory oversight, civil and criminal justice, etc. It cannot process simple requests such as visa and work permits for non-EU nationals in a quick and effective manner. A key area of growth is via privatisation of under-performing public assets and enterprises: SYRIZA has announced they will cancel nearly all privisatisation (SYRIZA’s position is not entirely clear-they have since announced that privatisations will go ahead).
Untapped natural resources or other strategic advantages. A key issue is whether the country in question is incurring debt for a major development objective, or whether it has untapped natural resources available for development. Greece does. Greece has unique cultural heritage and physical landscapes, major tourism investment potential, and important potential in agriculture, secondary homes and retirement homes, energy (petroleum and natural gas exploration), minerals, and many other sectors. Unfortunately, this potential is being strangled by continual government bureaucracy and political flip-flops of the most amateurish kind.
Trust in the government. The critical element in debt sustainability is trust in the government. In order for a creditor to lend, or an investor to invest, or a citizen to spend, they need to trust the government. Trust of the Greek public sector was already in short supply over the past 5 years. Trust right now is non-existent, unless a new arrangement on the Greek debt can be reached.
Absence of natural disasters or force majeure incidents. Another critical element is to avoid natural disasters (earthquakes, floods, fires, etc) or political risk (war, civil war, terrorism, rebellion, etc). So far, Greece has been able to take advantage of negative events in Egypt, Turkey, Tunisia and other traditional holiday destinations, which has boosted tourism tremendously.

So to answer the question: is Greek debt sustainable?

Yes, in purely financial terms the Greek debt is sustainable, providing there were a growth-oriented government making rational decisions in power. The Eurozone partners have shown willingness to adjust the burden of the debt in the past (see ECCL), and there are some very practical steps that can be taken to reduce the debt cost. Greece has a number of areas in the real economy where it could very quickly raise income and attract investment which creates real employment.

But the issue at stake here is not financial, it is political. SYRIZA came to power employing maximalist campaign promises and a negotiating style that was born in confrontational take-overs of public buildings and institutions by the Communist party (which is where many key SYRIZA leaders had their start). This political perception has led SYRIZA to make demands which are simple non-starters in financial and legal terms, and which in any case will not solve Greece’s problems.

Take a simple example: SYRIZA’s demand to write off 50% of Greek national debt. Remember that 80% of Greece’s debt is in official hands, while 20% is in private hand. Assuming that the 50% were equally applied (it will not be, because in the meantime SYRIZA has promised that the IMF, ECB and possibly private debt will not be touched), then the main impact would be a reduction of 50% of the existing interest rate. So, from € 5.7 billion in 2014, interest would only have been € 2.85 billion.

With € 2.85 billion in interest, Greece would have just reached break-even or a modest surplus in 2014. But even reaching break-even does nothing to gain the funds that SYRIZA wants for its social programme. And the collateral risks of its approach are far higher than any gains:

A 50% debt write-off creates a major financial loss for the European taxpayers who lent the money to Greece.

It creates the greatest financial loss to the ECB and EFSF, which are precisely the two institutions lending to Greece at the lowest interest rates and with the most generous terms.

It raises key questions as to why Greece should remain a member of the Eurozone or the European Union, since it no longer adheres to European agreements.

It will make the future rescheduling or refinancing of the remaining public sector debt impossible. Certainly, the idea that China or Russia will lend money to the Greek government without conditionality when the government has just stiffed its European partners laughable.

It makes attracting foreign investment difficult or impossible. The only foreign investors in the short term will be the very vulture funds that SYRIZA has spent so much time haranguing against.

It solves none of the root causes for Greece’s poor public sector financial, governance or social performance.

“Gaining” € 2.85 billion in interest barely begins to pay for SYRIZA’s promised tax reductions and increased social spending.

As a result, we believe that unless Greece dramatically improves its standards of governance and implements a growth programme based on real regulation and best practise, it will fail. So the issue is not really debt sustainability. The issue is whether or not Greece will end the current system of governance and finally adopt and implement the European standards it has promised to do since it joined the European Union in 1981.

Philip Ammerman