- Greece is insolvent, uncompetitive and stuck in an ever-deepening depression, exacerbated by harsh
and excessive fiscal consolidation. It is time for the country to default in an orderly manner on its
public debt, exit the eurozone (EZ) and return to the drachma to rapidly restore solvency,
competitiveness and growth.
- Exit will require a conversion of euro liabilities into the new currency to limit the balance sheet
effects that the depreciation of the new national currency will entail.
- Greece can exit the monetary union in an orderly and negotiated manner (i.e. limit the collateral
damage to its own economy and financial markets that this exit would imply) if orderly mechanisms
are used and appropriate official finance is provided. Such official finance to Greece and other EZ
members under stress will limit the contagion and the losses for other periphery and core creditor
countries, and will ensure that the domestic Greek financial system and economy does not suffer a
- Default and exit will be painful and costly, but the alternative of a decade-long deflation and
depression would be much worse, economically, financially and socially.
- Moreover, there are historical precedents for countries successfully taking the route of an orderly
default on unsustainable foreign liabilities and exit from unsustainable currency pegs and/or currency
Why a Default/Debt Reduction and an Exit From the EZ Are Necessary and Desirable
Greece is now in a vicious circle of insolvency, lack of competitiveness and ever-deepening depression, exacerbated by draconian fiscal austerity that is making the recession much worse. Greece’s public debt is heading toward a level of 200% of GDP in two years’ time. And while fiscal austerity and structural reforms are necessary to restore medium-term debt sustainability and growth, in the short run they will lead to an even deeper recession, thus making the deficit and debt even more unsustainable. Indeed, the latest economic data suggest that the Greek recession is becoming a near depression, with GDP expected to fall by over 7% this year and with forwardlooking indicators of economic activity (such as the PMI, which is at a level of 43) suggesting a deepening recession. Argentina in 1999-2001 fell into the same trap of deficit, austerity, deeper recession, depression, higher deficit, greater insolvency. Thus, it is time for Greece to orderly restructure/default on its public debt, exit the EZ and return to the drachma to restore solvency, competitiveness and growth.
First, the recent debt exchange deal negotiated to bail-in Greece’s private creditors was an outright rip-off for the country: The net present value (NPV) debt reduction was formally only 21% when the country needs at least 50% debt relief, based on RGE’s analysis of debt sustainability. And even that 21% headline is not a true measure of debt relief as a massive sweetener for creditors in the form of a Brady-style principal collateral guarantee will increase Greece’s gross public debt by another €30 billion. So, doing the math right and considering a likely rather September 16, 2011 ECONOMIC RESEARCH 2 Page | 2 www.roubini.com NEW YORK – 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | firstname.lastname@example.org LONDON – 174-177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | email@example.com | firstname.lastname@example.org © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent. than optimistic exit yield, the true debt relief for Greece out of this deal is at best close to zero or, at worst, possibly an NPV increase in its debt burden. Greece should put a halt to this unfair debt-exchange offer and, under threat of outright default, negotiate a better deal (with no credit sweeteners) that offers at least a 50% debt relief to the country. Going for the current deal now and hoping to negotiate something better in a second round is a much more difficult task: Given the full guarantee of the €100 billion principal via the collateral private sector creditors, the credit risk for private creditors would now be limited to the coupon payments, a paltry €5 billion per year. Then, further insolvency and the need for more debt relief for Greece would imply that the official sector (IMF, European Financial Stabilization Mechanism, European Financial Stability Facility and ECB), which is already bailed in via an effectively coercive maturity extension of its claims, would have to suffer a major and draconian haircut on its claims, thus becoming junior to private creditors. Thus, Greece should renegotiate a better deal—and one that keeps its debt under the domestic governing law, unlike the current debt exchange that transfers such governing law abroad—rather than accepting a lousy fake debt relief now. It would be better if the current debt exchange fails—with less than 90% of creditors accepting the offer—so that the country can target a fresh approach with greater debt relief, rather than going into a debt exchange where additional debt relief would have to come mostly from allegedly more senior official creditors, rather than formally more junior private creditors that end up being more senior. A formal default will not be necessary to achieve meaningful 50% debt relief; a credible threat of default if creditors don’t accept an exchange offer at more favorable terms would be sufficient. Currently, many creditors of Greece are holding out even on the current most generous exchange offer because they hope they will be paid in full as the EU/ECB/IMF want to avoid, at any cost, a technical default. Only a credible threat not to be paid will bring recalcitrant creditors into line.