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Greece – Haircut hopes

March 7th 2012Some of the biggest private-sector holders of Greek debt have said that they will support a package slashing the value of their holdings by more than 70%. That feeds hopes that the deal will go through on March 8th, knocking around €106bn (US$139bn) off the value of the country's private debt and unlocking a €130bn bailout loan from multilateral lenders, the second the country has required. That would banish fears of a disorderly default for the moment. Two big questions remain, however. First, over how messy the agreement with private creditors will prove to be. And second, over whether this deal offers enough to sort out Greece's problems.Even after this reduction, debt repayments will remain unaffordable. And the brutal austerity measures the country is being forced to adopt look impossible to implement. Therefore the budget deficit will remain high, debt levels will soar again and the country will face another debt crisis in a few years' time, even if it can force this deal through.

On March 5th, the 12 financial firms that make up the steering committee of the Institute of International Finance (IIF), an industry lobby group, said that they would take part in a scheme to swap their Greek government bonds for longer-term, lower-yielding securities, booking a nominal 53.5% loss on their debt (a real 70% when interest losses are taken into account). The 12 include many of the biggest holders of Greek debt such as Germany's Commerzbank and Allianz, and France's BNP Paribas. In total their holdings tot up to around a quarter of the €206bn of Greek debt in private hands, according to industry estimates, with the Institute's 400-plus members holding a bit over half of the total overall. Therefore, while there is no guarantee that all of its members will agree to the deal, IIF backing is an important indication that a majority of private debt holders will sign up to the scheme, with a final tally of participants due late on March 8th.

Greek finance minister Evangelos Venizelos is talking tough about the plan, claiming that he expects around 90% participation. "Whoever thinks they will hold out and be paid in full is mistaken," he said. "… our target is near universal participation." Euro zone finance ministers clinched the deal last month after consulting with industry bodies including the IIF, so there is little surprise that it is supporting the deal. However, the concerns are over more peripheral debt holders, such as international hedge funds that bought Greek debt at a discount in the hope that its value would increase and some Greek state pension funds, which have said they will oppose booking a loss after being forced to buy government debt. That means that, for all the finance minister's bullishness, uncertainty remains over the final number of private creditors who will agree to the debt swap.

Will they play ball?

The guess among industry analysts is that 80-90% of debt holders will agree to the haircut, meaning that the deal will go through but in a rather muddlesome manner. Multilateral lenders including the IMF have agreed to give Greece a second bailout package, but only if the deal with private creditors goes through. If it doesn't then Greece, shorn of multilateral cash, will struggle to repay its debts and could default within the month—meaning that private bondholders could lose all of their money.

The threat is harsh enough to allow the Greek finance ministry to use ruthless talk about this deal, effectively telling private lenders that they have little choice but to accept it. Greece needs the support of 66% of bondholders to force the swap through, but says it will scrap the plan if fewer than 75% sign up. At 75-90%, it will consult with the EU and IMF over how best to make good the losses, but will likely use a measure inserted into its bond agreements last month to force non-signatories to participate: collective-action clauses allow Greece to enforce the losses on non-volunteers, although there could be a messy legal battle as loss-bearing financiers try to recoup their money through credit-default swaps (a sort of insurance on bonds). Only above 90% would the deal definitely go ahead. Bond holders who do not agree to the swap will simply lose their money, the ministry says.

The threat of a disorderly default makes this debt-reduction package likely to scrape through, on balance. If it does not, then Greece will struggle to refinance around €14.4bn of debt on March 20th. That would lead to a disorderly default, and might lead to it leaving the euro zone with devastating economic, political and social costs. The damage would be likely to spread to other struggling euro zone states such as Portugal and Spain, feeding a possible banking crisis as the sovereign debt crisis spread to commercial banks. That in turn would lead to a deep European recession as business and consumer confidence collapsed, and it might even lead to the break-up of the euro zone. The stakes are high enough to make private lenders go along with this deal, if only because a euro zone collapse would threaten their own existence.

However, the bond swap will not solve Greece's problems. The idea is to cut Greek debt from around 160% of GDP today to 120% by 2020 (about the level of Italy's debt at the moment), but that is still not affordable: the Economist Intelligence Unit reckons the debt burden needs to fall to 80-90% of GDP to be manageable. Nor do we think that the 2020 debt target will be met. This deal is supposed to cut debt to 120% of GDP, but keeping it at that level requires unprecedented austerity measures that look impossible to implement. There have already been big demonstrations against brutal public-sector wage and job cuts, which will be very hard to sustain. Nor are other measures realistic, such as a pledge to reduce Greek public spending on outpatient medicines to 1% of GDP by 2014 (from around 4% today). That means Greece will continue to run a big spending deficit, forcing debt levels up again. Greece is sunk without this private-debt deal. But while the immediate crisis might well be averted, another one looks inevitable.