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Sunday, December 28, 2014

Paul B. Kazarian: "Greece Has Practically No Debt!"

Mr. Paul B. Kazarian recently made the news by offering, through his investment firm Japonica Partners, to purchase up to 2,9 BEUR of Greek bonds. Virtually unknown at the time of the offer, the WSJ researched its files and compiled this article about Kazarian.

In a subsequent 41-minute video (see the Logiki Ellada blog for the video), Kazarian explained why he is so bullish on Greece. In Kazarian's analysis, Greece has a huge competitive advantage which no one, other than himself, has recognized to date.

It is well known that the greatest investment opportunities are where the 'perceived risk' is much higher than the 'real risk'. The perceived risk of Greece is obviously very high these days. The real risk, so Kazarian claims, is much, much lower; in fact, significantly lower than that of other countries of the periphery.

Kazarian makes two principal claims: (a) Greece's net debt to GDP ratio is, in actual fact, significantly below 60% and only about 1/3 of the ratio of peer countries. And (b) Greece's cash net interest payments are close to zero; i. e. no cost of debt service.

A layman may be a bit puzzled by this because he remembers that Greece's debt is always being cited at about 175% of GDP and the annual interest payments, according to ELSTAT, are currently close to 8 BEUR. What alchemy is Kazarian working with?

Kazarian's alchemy is called IPSAS, the International Public Sector Accounting Standards. Essentially, these standards aim at presenting the public sector accounts in the same way as the International Financial Reporting Standards (IFRS) require corporations to present their accounts.

IPSAS on debt
Debt is typically recorded at its nominal value, i. e. if the loan is 1 MEUR, the debtor would show a liability of 1 MEUR. IFRS provides for recording debt at its economic value instead of its nominal value. If the 1 MEUR are bonds which trade in the market at 50% of nominal value, the debt could be shown as only 500 TEUR. The Bank of Greece, for example, follows those accounting prodecures. Thus, the foreign debt which the BoG publishes is significantly less than that which the Ministry of Finance publishes.

Alternatively, one can also record debt at its net present value: 1 MEUR debt due today has a net present value of 1 MEUR. 1 MEUR debt due in 10 years from now, if it carries no interest, has a net present value of 1 MEUR discounted by a market interest rate. If the actual interest rate is subsidized, i. e. below market, the 'liability' of that debt declines.

Kazarian makes a claim which sounds outrageous but he says that he can provide detailed calculations to interested parties. That claim is: Greece's creditors have already sustained 340 BEUR in net present value losses from debt relief, 'thus providing Greece with extremely generous breathing space'. Kazarian calls this a 340 BEUR wealth transfer to Greece (149 BEUR from private creditors and 191 BEUR from official creditors).

I have not requested detailed calculations because I could make them myself on the back of a match box. About 80% of Greece's debt (roughly 275 BEUR) is due to official creditors at subsidized interest rates of 2% or less with very long maturities and substantial interest deferrals. Thus, the net present value of that debt is much lower than the one calculated on the basis of market interest rates and shorter maturities. Suppose that difference were 100 BEUR. Kazarian would then say that creditors have sustained losses of 100 BEUR or: there has been a 100 BEUR wealth transfer to Greece.

"We can understand how this number is not popular to discuss in Greece", says Kazarian. That is a major insight, indeed, because the Greek side would wonder where that 340 BEUR 'wealth' is today and, particularly, where that 'extremely generous breathing space' is.

Kazarian's overall case would have been more credible if he hadn't presented such outrageous mathematical calculations. Yes, Greece has received very substantial debt relief so far but the point is: if half of my debt is forgiven but I am still unable to pay the other half, I wouldn't want to be told by my creditor that he has just given me a wealth transfer of half of my debt.

IPSAS on in interest expense
Governments typically present their accounts on a cash basis. If the interest expense was 8 BEUR for 2014 but did not have to be paid until, say, 2016 (interest deferral), the budget for 2014 would show a zero interest expense. A corporation, on the other hand, has to accrue interest expense regardless of when it is actually paid in cash. Thus, the corporation would show an 8 BEUR interest expense for 2014 even though that interest would not be paid until 2016.

Kazarian starts with Greece's interest expense of 7,3 BEUR according to ESA 2010. That represents about 9,4% of revenues which is in line with peer countries (or roughly the same percentage as Germany's). Kazarian then deducts 2,4 BEUR which he claims is interest due to the EFSF but whose payment is deferred, i. e. no cash payment in the current year. He then deducts another 2,7 BEUR which he claims are ANFA/SMP rebates received from the ECB (my understanding is that such rebates would be due to Greece but they have not been paid yet). Thus, Kazarian concludes that Greece's gross cash interest payments were only 2,2 BEUR (3,4% of revenues) and not 7,3 BEUR.

To top it off, Kazarian calculates that Greece has an additional 2,1 BEUR benefit from investing liquidity stemming from official credits (like the unused bank recap funds), which liquidity costs below market, at rates up to 8%. Thus, Greece's real interest expense, according to Kazarian, was only 100 MEUR in that year or practically 0% of revenues.

SUMMARY
Kazarian calculates that Greek debt which is nominally about 350 BEUR (or roughly 175% of GDP) is actually, in terms of net present value, significantly less than 60% of GDP. And, more importantly, the cost of that debt is practically zero because the interest expense of 7,3 BEUR (9,4% of revenues) which the books report are actually only 100 MEUR (0% of revenues when rounded). This is what Kazarian calls the 'huge competitive advantage of Greece'.

Kazarian concludes that, if and when the world becomes aware of that 'huge competitive advantage', foreign capital will again chase investment opportunities in Greece and the cost of financing for both, the public and private sector, will literally collapse. Small businesses will resurge, construction markets will reawaken, exports will increase given the new competitiveness and the value of income-producing real estate will also increase given the lower capital costs. Within the next 24 months, 200-400.000 sustainable new jobs will be created, according to Kazarian.


My analysis of Karzanian's analysis
Some points are well taken. Clearly, Greece has received very substantial debt relief so far, be it the PSI and/or the highly subsidized terms of the official loans representing about 80% of Greece's debt. And, yes, Greece's interest expense (in terms of a percentage of government revenues) is really not very high at all and certainly a lot lower than one would expect of an 'overindebted country': Gross interest expense of less than 10% of government revenues is more reminiscent of countries like Germany or Austria and far from the percentage of countries with debt problems and austerity challenges due to the debt. Greece itself had debt problems during the 19th century and, during those days, interest expense amounted to 30% (or even more) of government revenues.

But that's about the extent of what is credible in Kazarian's analysis. To assume that foreign capital will start chasing investment opportunities in Greece the moment it discovers Kazarian's logic is a bit of an illusion. Kazarian should ponder a hypothetical situation where all of Greece's debt would be forgiven. Would Greece's problems be solved? Short-term, yes, because Greece would have a renewed borrowing capacity. Long-term, Greece's problems would only be solved if that new borrowing capacity could/would be used for revenue-generating investments instead of domestic redistribution and/or imports.

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