To Repay or Not to Repay Debts?

BRUSSELS – For months now, a fight over sovereign-debt restructuring has been raging between those who insist that Greece must continue to honor its signature and those for whom the country’s debt should be partly canceled. As is often the case in Europe, the crossfire of contradictory official and non-official statements has been throwing markets into turmoil. Confusion abounds; clarity is needed.

The first question is whether Greece is still solvent. This is harder to judge than is the solvency of a firm, because a sovereign state possesses the power to tax. In theory, all that is needed in order to get out of debt is to increase taxes and cut spending.

But the power to tax is not limitless. A government determined to honor its debts at any cost often ends up imposing a tax burden that is disproportionate to the level of services that it supplies; at a certain point, this discrepancy becomes socially and politically unsustainable.

Even if the Greek government were to succeed shortly in stabilizing its debt ratio (soon to reach 150% of GDP), it would be at too high a level to convince creditors to continue lending. Greece will need to reduce its debt ratio considerably before it can return to the capital markets, which implies – even under an optimistic scenario – creating a primary surplus in excess of eight percentage points of GDP. Among advanced-country governments, none (except oil-rich Norway) has managed to achieve a durable primary budget surplus (revenue less non-interest expenditure) exceeding 6% of GDP.