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Revising the Greek bailout: Two more years of extend and pretend?

26 Oct 2012

Revising the Greek bailout: Two more years of extend and pretend?

It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

How much will a two year extension cost?

The delay in the deficit reduction plan could cost €14.04bn.  

Privatisation was expected to raise €23.5bn between 2012 and 2016, but clearly, this will not be done. Little to nothing will be raised this year while the projections up to 2016 are expected to be reduced by €9bn (according to the draft proposals). In total then the expected privatisation revenues could be €12bn lower than expected.

In the first half of this year government arrears increased by €1.24bn, despite being scheduled to be decreased under the Greek bailout programme. We expect a similar story to take place in the second half of the year, potentially adding €2.5bn in total to Greek financing needs.

Total cost of extension: €28.5bn

How could this two year extension be funded?

1. Interest rate reduction

  • The IMF’s (due to seniority) and the private sector’s (due to legal protections under new bonds issued after the debt restructuring earlier this year) holdings are unlikely to be included. This rules out a huge amount of Greek debt.

  • Around €148bn in official loans will have been given to Greece (after the next tranche), with around €22bn from the IMF (which is off limits), €52bn in bilateral loans and €74bn from the EFSF.

  • Currently the premium (over cost) charged on the €126bn in eurozone loans is 1.5%. Even if this was all wiped off this could only save around €1.9bn (similar to previous estimates by the Eurogroup). Even if it were applied to future loans, which equal a further €71bn from the EU, this would still only save around €1bn.

Potential saving: €2bn - €3bn
Likelihood: Very likely

2. Increased short term debt issuance and further austerity

  • Greece issues further short term debt (T-bills) and finds further budget cuts to cover its financing needs. Greece’s stock of T-bills is around €15bn. Greece could potentially double this stock but at a borrowing cost of around 4% - 5% (€600m - €750m).

  • Further austerity will be politically and economically difficult but there may be little alternative.

Potential saving: €15bn (in T-bill issuance), €5bn - €10bn from austerity
Likelihood: Possible

3. Rescheduling debt (extending the length of Greek loans)

  • Contrary to some reports, repayment on the official EU loans does not begin until 2020, making any rescheduling pointless for this time period. Given the restructuring nearly all private sector debt is held at long maturities between 11 and 30 years.

  • There is €9.1bn in IMF loans maturing over the next two years, so a delay could offer some relief. However this is strictly against the IMF rules and in many cases is viewed as a default. Even if it were to happen it only provides a temporary solution as it still has to be paid off later.

Potential saving: €9.1bn (in the short term) but zero on net over the long term
Likelihood: Unlikely

4. ECB forgoing interest and/or profit

  • The ECB holds around €46bn in Greek bonds while National Central Banks (NCBs) hold a further €11bn, mostly believed to be shorter maturities.

  • An interest rate reduction on these bonds of between 2% - 4% could raise between €1.15bn and €2.3bn. This could be hard to achieve due to all the new bonds being governed by English law and including cross default clauses.

  • Forgoing the profits on these bonds could raise around €14.25bn (assuming a purchase price around 75% of nominal value) but this would be direct monetary financing – meaning the ECB would never agree to it.

Potential saving: €1.15bn - €2.3bn (interest rate cut), €14.25bn (forgoing profit)
Likelihood: Unlikely (Interest rate cut), Very Unlikely (forgoing profit)

5. Bond buybacks

  • This idea has been rejected by the Greek finance ministry and the EU/IMF/ECB Troika, but given that this idea has already hung around for two years it could well surface again.

  • Around €121bn of debt is eligible for repurchase. We assume the holders of the €6bn in bonds which escaped the previous write down would once again not take part, except at exorbitant prices. Domestic Greek banks and other financial firms hold around €42.5bn. They are unlikely to be able or willing to sell these bonds as it would involve taking losses on their books but also since they need them as collateral for ECB liquidity – i.e. this €42.5bn cannot be touched without putting the entire financial sector in Greece at risk.

  • That leaves only €72.5bn which could possibly be bought back and retired. Greek 10 year bonds are trading at around 30%. Assume this is the average purchase price with 90% participation (sale). This gives around €65.25bn that can be retired. This would cost €19.6bn to purchase, leaving a debt reduction of €45.65bn (22.4% of GDP, bringing debt to GDP down to around 138%).

  • After paying for the €28bn cost of the two year extension, this option would deliver an additional €17.15bn (8.4% of GDP) reduction to Greek debt. This doesn’t take into account potential bond price rises as a flood of official demand hits the market.

Potential saving: €45.65bn overall, €17.15bn after the two year extension is paid for
Likelihood: Very unlikely (as this goes far further than simply the two year extension)

6. Write-down original eurozone bilateral loans

  • There are currently around €52bn in bilateral loans dispersed to Greece, writing these down by 50% could raise €26bn.

  • This seems unlikely due to political and legal problems – it would crystallise previous loans into a permanent transfer (allowing for new challenges at the German Constitutional Court and the European Court of Justice). It would also need approval from national parliaments, with Germany, Finland and the Netherlands likely to put up a strong fight.

  • Writing down the IMF and the EFSF loans seems impossible, especially since they would be expected to continue funding Greece after the fact.

Potential saving: €26bn - €52bn
Likelihood: Very unlikely

What is the most likely outcome?
As our discussion of the options above shows, Greece and the eurozone are stuck between options which are easy but deliver minimal savings and those which are almost politically, economically and legally impossible but could deliver the amounts needed.  

We expect a short term stop gap programme to be created with a mixture of option 1 and 2. This is likely to be the most painful for Greece but the easiest for the creditors to swallow. Unfortunately, this will add to Greece’s debt burden rather than reduce it, meaning a longer term decision will need to be made over the less palatable options. In any case, even if a mechanism of funding this extension is found, Greek debt still looks unsustainable, meaning questions over a Greek exit will continue to hang over the eurozone.  

For more information please contact the office on 0044 (0)207 197 2333, or the author Raoul Ruparel on 0044 (0)757 696 5823.

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