What might a Greek debt deal look like?

February 6, 2015

The current Greek debt situation is unsustainable. The idea that Greece is going to grow it’s bankrupt economy enough to find 320 billion Euro over the next thirty years or so, and start making repayments later this year is clearly absurd.

Everybody, including the Germans, knows that a big chunk of the Greek debt will eventually be written off, or at least quietly forgotten. The reason that no apparent write off of debt can occur now is purely political and is mostly about the domestic politics of Germany although there are also political constraints at an EU level.

Syriza has made a strong case that continuing austerity will crush Greek growth making any debt repayment much harder, and that even a small increase in social spending would greatly reduce the human suffering caused by the collapse of the economy.

What has been proposed by the Syriza is not entirely clear. That partly seems to be the result of the sort of confusion that happens if there is a rush to find a solution to a massive, and technically complex, political problem by a new administration composed of politicians new to government. But it is more likely to be the result of deliberate Syriza tactical negotiation manoeuvre, i.e. ask for one big thing (write debt down now) but actually be prepared to accept another (no write down but a debt restructuring).

Any deal needs to have the following components.

It must not appear to contain any write off of Greek debt.

It must include a way to minimise any repayments by the Greeks in the near future (i.e. the next decade or so).

It must allow Syriza to gently reflate the Greek economy.

It must allow Syriza to address some of the worst humanitarian problems caused by the crisis (the position of pensioners, health care), none of which is actually very expensive.

It must be a deal that appears strong and is widely supported by all parties so confidence in the Greek economy and banks can return.

If the deal is complex and full of arcane financial terms then that actually helps ease the political problem of selling it to the German public.

Yanis Varoufakis has made some proposals that would involve two new types of debt, one linked to GDP for the IMF and holders of Greek sovereign debt, and the other of perpetual debt, which would replace Greek debt held by the ECB and which would be repaid as and when Greece is in a position to do so.

This proposal is for a conversion of the existing dated ‘debt’ liabilities into a modern form of the undated credit instrument (‘stock’).

Firstly, Greece would dedicate an agreed proportion of tax income to long term funding. Let us say 5% of Greek tax income and an initial allocation of 12 billion euro.

Greece then issues stock (undated credit instruments) at a discount, each of which is returnable in payment for one euro of Greece’s taxes. This new issuance would then be allocated between the different creditors in a way reflecting the repayment date and interest rate of Greek liabilities.

From then on Greece would use 5% of its tax income to buy back this stock for cancellation, and the faster the growth of Greek GDP and taxation, the faster would be the rate of return of the stock.

This how it might work in practice.

Greece has existing aggregate public liabilities of 320 billion euro (rounded up to the nearest 10 billion). Let us say that Greece exchanges 480 billion prepay tax credits of one euro each for the outstanding 320 billion euro debt. The holders of these instruments will make an aggregate profit of 160 billion euro or 50% when these instruments are returned by being bought back at the one euro par value.

The rate of return per annum then depends upon how many years it takes for Greece to buy back these instruments. At a constant GDP/rate of tax collection this will take 40 years (480 billion euro divided by initial tax allocation of 12 billion euro).

So the rate of return will be 50% profit divided by 40 years or 1.25% per annum. If tax collections fall the rate of return will be less (slower), while if tax collections rise, whether from increased GDP or more effective tax collection or both, then the rate of return will be higher (faster).

Once such a deal was in place the Syriza government could focus on measures to address the humanitarian crisis, the reforms needed to break the power of the old corrupt oligarchical elite and measures to attract investment in order to grow the economy.

Later, in perhaps ten or twenty years, when the political heat has gone out of the whole issue the outstanding debt mountain, mostly owed to various public bodies, can be quietly written down and by then almost nobody might notice.

There are a lot of clever people involved in trying to sort out this mess out and what the Greeks want, and what Yanis Varoufakis has been saying, is if this stops being approached as a conflict between two sides but rather as collaborative effort in the spirit of European solidarity to solve a mutual problem, which is that the current debt management package is clearly unworkable, then solutions are possible.

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