By Ashoka Mody
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.
Ashoka Mody is
a visiting professor of International Economic Policy at the Woodrow Wilson
School of Public and International Affairs, Princeton University.
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