Tuesday, May 24, 2016

Considerations On Debt Relief

A nominal reduction of debt (via forgiveness) has the advantages of reducing the indebtedness ratio (debt as % of GDP) and reducing the interest expense in the budget (if the debt is interest-bearing). Put differently, such a debt relief is debtor-friendly.

Debt relief in the form of extending maturities does not reduce the indebtedness ratio and it only has the same benefits for the budget as above if interest on that debt is reduced to zero. This form of debt relief is creditor-friendly because creditors do not have to make write-off's.

From the standpoint of the budget, it is irrelevant whether debt relief comes via debt forgiveness or via reducing interest rates to zero. In either case, the budget is relieved. One could argue as follows: "If the benefit is the same either way, we'll chose the creditor-friendly way because that way we can build up goodwill with the creditors".

Since Greece already has zero interest expense on most of its debt with the EU, one could question the point of insisting on debt relief from the EU. There wouldn't be an immediate benefit to the budget from any debt forgiveness. Which brings me to the most important point.

Debt relief in the form of debt forgiveness has the ultimate objective that the borrower can return to capital markets and borrow again it its own name without any support from third parties. Put differently, if all of Greece's debt were forgiven, the major benefit would not be so much the fact that there would no longer be interest expense. The major benefit of such a decision would be that Greece could start (again) to borrow in international markets.

Greece borrowing again freely in international markets? Has that happened before? Has that led to positive outcomes?


  1. The IMF argues that clarity is necessary to restore investor confidence.


  2. In 2010, the Europeans didn't listen to the IMF. It was because they hadn't previous experience in managing crisis. It wasn't because they wanted to allow to their banks to unload their greek bonds.

    In 2016, the Europeans didn't want to listen to the IMF. Germany wants to discuss situation in 2018. It's not because Germany has elections in 2017 and Schauble wants to present himself as champion of the just. It is because it has no sense.

    The beauty in all this. Whatever happens, you can always say that you were right and blame it all to Greece. A win win.

    Of course, those to blame are only the greek politicians, who allowed the country's fate to be in the hands of the lenders. Conflict of interest.

  3. Maybe it would be interesting, to combine your article with another on "how the IMF is wrong, on expecting 3,5% primary surplus and why Germany insists on doing so and maintaining for 10 years".

    I will only relay what Mrs. Lagarde said yesterday:

    "No other economy has ever achieved that, given the estimation that the unemployment will remain in double digits".

    Yet only yesterday, Mr. Schauble, stated that Greece will achieve it.

    There are 2 probabilities i can possibly see.

    1) The IMF is right.
    2) Mr. Schauble is right.

    Given how many times the program set unrealistic targets, i am worried that case 1 might be true!

    But, worst case scenario if it is true? Political turmoil increases to Greece and Grexit happens. Something proposed by Schauble himself since 2012. Not so bad!

    I write this, because the surpluses are obviously related to debt sustainability.

  4. http://i.imgur.com/Lo7CToz.png

  5. http://www.naftemporiki.gr/finance/story/1108667/auksisi-tou-pleonasmatos-xari-stis-meiomenes-dapanes

  6. So Greece must not have debt forgiveness, so that She won't return to the capital markets soon, because last time She was there, She overindebted Herself.
    Never mind Greek national interests, sovereignty, never mind the welfare of the Greek people; She must be kept on a tight leash, for Her own good of course.
    A creditor-friendly argument indeed.

    1. By and large, you are correct (except that you phrase it in an unnecessarily aggressive manner). In fact, that's what Maastricht had stipulated with the debt limit of 60% of GDP.

      As the Greek experience has shown, bonds issued by one EZ country are, in the final analysis, Eurobonds because if Greece has not been let down by the EZ, then no other country ever will be, either.

      When debt issued by party A represents, in the final analysis, an obligation of parties B-Z, it is only natural that parties B-Z want to have control over the amount of debt issued by party A. That would appear to be only logic.

      Schäuble claims that Varoufakis once told him that if even if all of Greece's debt were forgiven, Greece would be in the same box again in a few years from now. I would agree with that. Greece's business model since 1981 has been to build up a welfare state financed not with economic value generated on its own but, instead, with debt borrowed offshore. Only if and when that business model gets ever changed will the capital markets be good news for Greece.

      And, by the way, why would Greece want to return to capital markets when the cost of borrowing there is a multiple of the cost of EU debt?

    2. Dear host,
      I'm afraid that I can't leave uncommented how easily you claim that parties A, B and C (B-Z ? Really?) stand on an equal footing on the matter; and what's worse how you have omitted to mention that parties B and C might have benefited at party's A expense either willfully or unintentionally. Leaving pre-2008 aside, to my eyes, EU structure served to turn the periphery into a kind of "shock absorber " for the core to cope with the global financial crisis ( as it's the case for years now with the various migrant and refugee crisis) until the expatriated capital safely returns home … (And perhaps until even that turns out to be not enough) But then again I must admit that how I see things is colored by my own sympathies and prejudices. Yet even you, if I'm remembering correctly, you have written somewhere something similar, albeit framing it as a "natural" law of global economics...

      When it comes now to Anonymous' (May 28, 2016 at 4:21 AM) supposed aggressive manner, also there I beg to differ. Why should plain honesty be more offensive than arguments essentially formulated as: "it only stands to reason that what serves me is the just - and polite! - thing to do!"?

    3. @ Lykinos
      Have different EZ members benefited at the expense of others, willfully or unintentionally? Definitely yes!

      The top item in my mind is the external exchange rate of the Euro. Everyone agrees that if a strong country, say Germany, issued its own currency, that currency would go through the roof. Vice versa, if a weak country, say Greece, issued its own currency, that currency would collapse. So Germany's exports are subsidized by an undervalued exchange rate which undervaluation is made possible by the weak countries which, at the same time, still suffer from an overvalued exchange rate. German exporters benefited at the expense of Greece; Greek consumers benefited at the expense of European tax payers who will eventually pay for Greece's consumption debt.

      Then comes the interest rate conversion. Prior to the crisis, that conversion was seen as proof that the EZ worked well because Greece could borrow almost at the same rates as Germany (before, I believe Greece paid at least 7% more than Germany, reflecting Greek risk). When borrowers of different risk can borrow at the same rates, this leads to a distortion which will eventually blow up. Since Greece still paid a little more than Germany, the funds went to Greece. However, since borrowing had never been so cheap and so easy for Greece, Greece overborrowed and put the money to bad use. Greeks benefited from a Euro-party and now have a 6-year hangover. European tax payers will eventually end up paying for the party. I should add: the fact that Basel 2&3 told banks that sovereign EZ debt was risk-free only added to the above development.

      I maintain that the financial crises in the periphery had very little to do with the 2008 crash. Those crises were the result of too much money flowing into economies as debt. That in and by itself would not have to be a problem. Instead, it could be a huge bonanza if those monies had been spent/invested well. Unfortunately, where they were invested (like Spain), those monies went into stranded investments (ridiculous real estate boom). In Greece, on the other hand, most of the monies were spent on living standards. At the end of the day, it doesn't matter whether debt is unwisely invested or simply spent --- the bust cannot be avoided regardless of a Lehman happening or not. The only thing which a Lehman does it to make the bust happen overnight.

      One aspect is generally overlooked when commenting about Greece. I can understand that because it is not tactful to talk about joys when many people are suffering. I will still do it now.

      Think of Greece's living standards, infrastructure, etc. back in 1981, at the time of the EU entry when money started flowing to Greece. Think of Greece before the EZ entry when money flows assumed the character of a tsunami. And look at Greece today. Despite all the hardships and depression, you see living standards, infrastructure, etc. (and foreign bank deposits!) which the Greek economy could not under any circumstances have accomplished on its own. I know that the no-income Greek unemployed will accuse me of being irresponsibly cynical when saying that but the point is: when you ignore individual sufferings and look at the entire Greek society as a whole, as a whole Greek society benefited tremendously financially from having joined the EZ (except that the fruits were distributed totally unfairly). Everyone who is honest knows today that Greek debt can never be repaid at market conditions. The only question is whether the eventual relief will take the form of forgiveness or long tenors at zero interest rates. The other question is how much that relief will be but I am sure everyone knows that it is going to be in the hundreds of billions. When you have borrowed a lot of money and you don't have to pay it back, that's an example of party A benefiting at the expense of party B.

    4. "Before (Eurozone entry), I believe Greece paid at least 7% more than Germany, reflecting Greek risk."

      I would like to clarify that a bit.

      Before Greece entered the Eurozone, most of it's public-debt was held domestically and was denominated in drachmas. This means that the cost of it's service was under the control of the Bank of Greece and it reflected the rate of inflation. It also means that it's service posed no problem since Greece could "print" drachmas at will.

      Obviously the above doesn't apply to Greece's public-debt which was denominated in foreign currency.

      This constraint (brought forth by the value of the drachma vis-à-vis foreign currencies) was beneficial for the Greece economy not only because it meant that it could not overborrow in a currency that it was unable to "print", but also because it acted as a doorstop on Greek jobs pricing themselves out of the international competition.

      Alas, when Greece entered the Eurozone, all this domestic debt transformed overnight to Euro-denominated debt (i.e. a currency that Greece cannot print and which is under the control of a central bank that does not support the bond-market of it's own member states). This is a huge design flaw of the Eurozone.

    5. @ Jim Slim
      I understand what you are saying but, nevertheless, I was referring to the premium which Greece had to pay over Germany on its foreign currency loans during Drachma times. The Drachma debt during those times, in my understanding, was even much more expensive than that (I once heard numbers like 12% or so).

      In short, Greece did have foreign currency loans prior to EZ entry and the premium over Germany was a multiple relative to post EZ times (when it came down to almost nil).

    6. @ Jim Slip
      Addendum: quite a bit of Greece's Drachma debt was also held by foreigners. Greece had entered double-taxation agreements with several countries, including Austria, which meant that Austrian residents, corporate or private, did not have to pay taxes on Greek interest income. I remember the 1990s when Greek sovereign paper denominated in Drachma was a go-go product for Austrian investors. They swapped the Drachma into Austrian Schillings (actually, we did the swap for them and made good extra income...) and despite the swap cost they still had a far better return than they could get in Austria. I remember being asked by corporate clients quite frequently whether one shouldn't be concerned about the risk of the Greek state and I always quoted what our research department had told us to quote: "Greece is a member of the EU. Do you really think a member of the EU can fail?" Well, I have to admit that we were quite innocent in those days...

    7. @ Jim Slip
      And yes, the constraint on getting loans from offshore was a good constraint for the country but it lost strength as the world entered into the 2000s. Banks not overloaded EZ-countries with debt, also local currency countries like Hungary (with CHF loans to finance retail housing in Hungary!!!).

    8. @ Jim Slip
      I should have mentioned Iceland as a country which was overloaded with foreign currency debt even though it had a local currency.

    9. About 70% of Greece's public-debt was denominated in drachmas. That is a significant amount to be re-denominated in a foreign currency, under the control of a central-bank that doesn't support the bond-market of it's own member states.

      That, along with the transfer of that debt from private entities to official entities (when the first bailout occurred) imho means that Greece has been dealt a bad hand. For all it's faults, Greece didn't deserve that.

      At the very least the Europeans should ditch the absurdly high primary-surplus targets. Enough is enough, how many tax hikes will the Greek economy tolerate? Taxes in arrears are close to 90 billion euros, non-performing-loans are over 50% of GDP, unemployment remains glued at 25%. The bailout programs all fail, one after the other, and yet the Europeans keep doing more of the same.

    10. That seems to be the fate when joining currency unions. When Germany unified the East, they offered the East the Deutsche Mark at 1:1. Great joy in the East at first. Then the East discovered that their liabilities were now in hard currency whereas their assets weren't worth that much in hard currency and their operations couldn't generate much revenue for lack of competitiveness. To this day, there are people who argue that the West truly raided the East during unification.

    11. http://crisisobs.gr/wp-content/uploads/2016/05/%CE%95%CF%81%CE%B5%CF%85%CE%BD%CE%B7%CF%84%CE%B9%CE%BA%CF%8C-%CE%9A%CE%B5%CE%AF%CE%BC%CE%B5%CE%BD%CE%BF_22_Paul-Adrien-Hyppolite-%CE%95%CE%9DG1.pdf
      Let's say it's interesting in its totality BUT:
      See Chart 11.
      It's of major importance.
      The BoG doesn't publish these data; in fact I've never seen, never read anything about the existence, the availability -albeit non-public- thereof till I read this paper wherein the author states he was given them after a personal request.

      Also of major importance (referenced in the above):

      The original Anonymous of this thread.

  7. Instead of debt relief, the Europeans should ditch the absurd primary-surplus targets (and the measures taken to achieve them).

    After the umpteenth tax hikes in six years of depression, it's only a matter of time before a majority demands to exit the Eurozone.

  8. The Eurozone will not deny them their reasonable demands to exit. After that they can run whatever primary targets they can find fools enough to finance.