Greece, even with bailout help, faces massive debt

February 14, 2012

Europe’s proposal for a new bailout of Greece would pump $170 billion into the country in the next three years and slice the value of the Greek bonds held by private investors by more than half.

But even if all goes well, the country would still labor under a mountain of debt that it may not be able to afford. If Greece misses its economic growth targets by even a small amount, this new bailout would run aground, international debt experts and analysts said.

On Tuesday, European finance ministers canceled a Brussels meeting scheduled for Wednesday to discuss the proposed rescue plan amid continuing doubts about whether Greek officials will meet the strict conditions for receiving new international loans. The Greek Parliament took an important step in that direction last weekend by approving new austerity measures, sparking violent protests. European leaders are squeezing the Greek government to make further progress in carrying out the steps,

Amid growing concern about the country’s plight, new data published by the Greek statistical agency on Tuesday showed that the economy, reeling from government spending cuts and other austerity measures, shrunk by about 6.8 percent last year. That rate of contraction outpaced estimates made by the International Monetary Fund just a few weeks ago.

The new program depends heavily on Greece returning to economic growth. Yet with a potential Greek default on its debts only weeks away, European and IMF leaders are expected to march ahead with the new loans regardless.

The alternatives — basically letting Greece default and possibly leave the euro zone — could be too risky until Europe builds a financial firewall strong enough to protect other countries such as Italy from fallout. Euro-region leaders have been working for more than two years toward erecting such a defense.

“As long as the IMF, the European Commission, the Germans and the European Central Bank feel that Greece cannot be cut loose, they are desperately trying to make the numbers add up” to justify the new program, said Sony Kapoor, managing director of the Re-Define consulting firm. Compared with further lending to Greece, “the alternative at this point, for all the major actors, including Greece, looks even worse.”

In a sign of the doubts about the new program, Luxembourg Finance Minister Luc Frieden said in Washington on Monday that the next round of international support for Greece may be the last.

“We should do our best to keep the euro zone with all its members, but the key lies with Greece,” Frieden said in an address at the Atlantic Council. If the strict conditions of the next international loans are not met, “they exclude themselves from the euro zone. . . . That might to some extent let Greece have a new start.”

The new rescue program — which has been the subject of wrangling among European officials, Greek leaders and the IMF — involves three pillars: massive new international loans, the imposition of steep losses on private bondholders and renewed efforts by Greek officials to reinvigorate the local economy.

The overall program is meant to lighten Greece’s debt load, fund the Greek government’s needs for the next three years, and tear down some of the regulatory and other barriers that the IMF says has made the Greek economy one of Europe’s least competitive.

Even if the program stays on track, Greece’s outstanding debt will remain among the highest in the world for years to come. After peaking at around 160 percent of annual economic output in 2011, the program aims for Greece’s debt to fall to 120 percent of gross domestic product in 2020.

That “is on the absolute high side of what is sustainable,” said Whitney Debevoise, a partner at the Arnold and Porter law firm and an expert in international debt negotiations. “There is still huge potential for slippage.”

The debt level has sparked debate within the IMF and Europe about whether it makes sense to continue lending to Greece. IMF rules only allow lending to countries that have sustainable levels of debt.

The level of debt that is considered “sustainable” varies country by country, and depends on the rate of economic growth, size, reputation in the market, interest rates and other factors. Japan carries debt at 200 percent of its GDP without trouble, while the United States, benefiting from the dollar’s role as a reserve currency, is hovering around 100 percent while the country enjoys record low interest rates. Spain, on the other hand, is facing trouble with debt levels at only around 80 percent of GDP because of doubts about its large government deficits and the health of the economy.

The IMF looks closely at whether a country’s government can generate what’s known as a “primary surplus.” That means that the amount of money collected in taxes exceeds the amount spent on services, government payrolls and other basic costs. A primary surplus does not take into account interest payments on existing debt, and basically means that the government has a bit left over to pay back what it owes. If the primary surplus is large enough, growth strong enough and interest costs low enough, then virtually any level of debt can be considered sustainable.

But that basic math is not all that matters. In Greece’s case, history does not offer much hope, said Carmen Reinhart, an expert in government debt and a senior fellow at the Peterson Institute for International Economics. In recent decades, the country has tended to grow slowly when its debts are high. So, she said, perhaps the only solution is to wipe out the “debt overhang” by imposing the largest possible losses on private investors.

Under the proposed rescue program, private investors in Greek bonds would shoulder some of the burden. But Reinhart added that it was “hard to get very excited about defining success as having 120 percent debt to GDP.”

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