Academic journal article Brookings Papers on Economic Activity

Greek Debt Sustainability and Official Crisis Lending

Academic journal article Brookings Papers on Economic Activity

Greek Debt Sustainability and Official Crisis Lending

Article excerpt

ABSTRACT The International Monetary Fund and the European Stability Mechanism softened their crisis lending policies repeatedly to deal with the Greek debt crisis, but the analysis of debt sustainability still acts as the gatekeeper for access to official financing. We explore the underlying mechanics of debt sustainability analysis and show that the standard model is inappropriate for Greece since it ignores the highly concessional terms of Greek debt. Greek debt has been restructured repeatedly, and now two-thirds of the stock contains grant elements of about 54 percent. The present value of outstanding Greek debt is currently about 100 percent of GDP and will rise to about 120 percent under the new program. Greek debt sustainability therefore is less a problem of the debt stock. By simulating different paths of the gross financing needs, we show that there may be liquidity problems over the medium to long terms (in particular, in 2035 and beyond). However, our estimation of the financing need is subject to high uncertainty and mainly depends on whether Greece will be able to regain access to markets at reasonable terms.

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Many people hold strong views on Greek debt. Just taking a casual look at the level of Greece's debt, which the International Monetary Fund (IMF) has recently projected to rise to 200 percent of GDP, it seems obvious that Greek public finances cannot possibly be sustainable (IMF 2015a, 2015b). What is not obvious is how this can be subject to dispute among the main creditor institutions. Greek official sector debt sustainability assessments have been quite volatile, but by the beginning of 2015 the verdict of the main official creditor institutions--hereafter referred to as the troika for short--was that Greek debt was sustainable. (1) Eight months later, however, at the time of this writing, the troika has split over the question of debt sustainability; while the Europeans are pushing ahead with a new program for Greece, the IMF is holding out. It seems that the diagnosis of debt sustainability is not so obvious after all.

One reason that a diagnosis of debt sustainability is complicated could be that politics plays a role, in particular the political feasibility of adjustment. Indeed, theory has long emphasized that sovereign debt is different from corporate debt, precisely because politics and institutions are crucial in determining a country's capacity and willingness to repay. (2) From this perspective, debt sustainability would depend, among other things, on the particular political coalition, the strength of political institutions, and even on the egos of decisionmakers and their negotiating power, both at home and abroad. Thus, debt sustainability would not only be unobservable and country-specific but also time-varying and highly volatile. Political positions can change very rapidly, as showcased by the turmoil caused by the Greek government's turnover in January 2015.

However, this is a perspective that neither the IMF nor the eurozone can adopt. As a matter of principle, they must ensure equal treatment across members and cannot constantly change the goalposts in accordance with shifting political circumstances. Thus, they need to deploy a framework to assess debt sustainability that can be applied to the entire membership. (3) In addition, this framework should be designed with the goals of both protecting the debtor country from overborrowing and protecting the resources of the creditor institution. An "unsustainable" verdict should preclude the official sector from lending into cases of insolvency and should require some form of debt restructuring first (IMF 2014a, 2014c). Understanding the basis of official debt sustainability analysis is therefore crucial. The first contribution of this paper (section I) is to present the models for sustainability assessment employed by the IMF and the European Stability Mechanism (ESM), and then to review the impact of the Greek debt crisis on the overall framework for international crisis lending. …

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