PRINCETON – The process of official forgiveness of Greek debt has begun. Referred to as “official sector involvement” (OSI), it includes several initiatives aimed at reducing Greece’s debt/GDP ratio to 124% in 2020, from roughly 200% today. Even as the deal was announced, however, newspaper reports suggested that officials recognized that the measures would be insufficient to meet the target; further negotiations on additional steps would be needed at a politically more convenient moment.
The economist Larry Summers has invoked the analogy of the Vietnam War to describe European decision-making. “At every juncture they made the minimum commitments necessary to avoid imminent disaster – offering optimistic rhetoric, but never taking the steps that even they believed could offer the prospect of decisive victory.”
This strategy needs to be inverted – and Greece offers a real opportunity to get ahead of the curve. Instead of driblets of relief, a sizeable package, composed of two elements, is the way forward. First, as Lee Buchheit, the attorney who oversaw the Greek private restructuring, has proposed, maturities on official Greek debt could be greatly extended. A simple structure would be to make all debt payable over 40 years, carrying an interest rate of 2%. This would move Greece and its official creditors beyond the continuous angst that now prevails.
The second element of the debt-relief package would be more innovative: If Greece’s economy performs well, the generous extension of maturities can be clawed back or the interest rate raised. A formula for this could be linked to the debt/GDP ratio – a scheme with advantages that transcend the Greek case. The idea of linking debt relief to a country’s debt/GDP ratio has been around for a while, but has never gained significant acceptance. Applying it in Greece would be a highly visible test; if successful, it would set a valuable precedent.
Why bother? Because the very premise of the current deal and the expectations it sets out are wrong. First, the notion that there is a smooth transition path for the debt/GDP ratio from 200% to 124% is fanciful. Second, even if, by some miracle, Greece did reach the 124% mark by 2020, the claim that its debt will then be “sustainable” is absurd.
Thus, continuing down this path will further erode policymakers’ credibility – not that they seem to care – while imposing on the rest of the world a persistent sense of crisis and uncertainty, with real financial and economic costs.
Make no mistake: policymakers’ track record on forecasting Greek economic performance during the crisis has been an embarrassment. In May 2010, the International Monetary Fund projected – presumably in concurrence with its European partners – that Greece’s annual GDP growth would exceed 1% in 2012. Instead, the Greek economy will shrink by 6%. The unemployment rate, expected to peak this year at 15%, is now above 25% – and is still rising. The debt/GDP ratio was expected to top out at 150%; absent the substantial write-down of privately held debt, which was deemed unnecessary, the ratio would have been close to 250%.
In September 2010, four months after the official Greek bailout was put in place, the IMF issued a pamphlet asserting that “default in today’s advanced economies is unnecessary, undesirable, and unlikely.” The conclusion was that official financing would carry Greece past its short-term liquidity problems. Calls for immediate debt restructuring went unheeded. Six months later, after substantial official funds had been used to pay private creditors, the outstanding private debt was substantially restructured.
Such were the errors committed over short time horizons. Relatively speaking, 2020 is an eternity away. Even assuming better forecasts, the projection of 124% could be a gross underestimate. The precision of the numbers underpinning the deal is a façade, if not a reflection of an alternate reality.
And, again, even if Greece somehow did achieve the 124% milestone, its debt would still not be sustainable. At that point, Greece would merely be where it started in May 2010. The most reasonable comparison is with Latin American countries during their debt crises in the 1980’s and 1990’s. Despite significantly lower debt/GDP ratios and continuous debt restructuring, they eventually needed the large debt reduction that came with the issuance of Brady bonds to achieve some breathing room.
Getting ahead of the curve will give Greece a realistic chance of controlling its own destiny. It will also be a reminder of the dangers of rushing in with official money where private debts have become unsustainable. Staying the course, as Summers warns, will lead only to “needless suffering” before that course inevitably collapses, bringing Greece – and much else – crashing down.