The Euro: three steps and a leap for survival
We have moved into a new phase in the euro crisis. The latest IMF and World Bank meetings provided the backdrop for intense discussions on the future of the euro and the need for action.
The IMF and EU are withholding the next tranche of the rescue package for Greece as they are unhappy about the progress being made in implementing fiscal consolidation.
Greece has responded with more measures, including a new property tax, which will be collected through electricity bills and will inevitably prompt more strikes.
But as in the US, these measures only kick the can down the road. Perhaps the most important development of the past month is the recognition by the EU, IMF and ECB (the Troika) that Greece is broke and will not repay its debts.
This is no longer seen as a liquidity problem, but as a solvency crisis.
Of course, markets have been saying this for some time: even a growing economy with a functioning fiscal system would struggle to reduce its debt levels from 160% of GDP.
Greece has neither: the economy is in its third year of recession and has no credible tax collection system.
In our opinion, Greece will need to impose a haircut of at least 50% on its debt to get itself back to a sustainable position.
Recognising the need to restructure Greek debt is the first step the Troika need to make to resolve the crisis.
The challenge then is to manage the process in an orderly way. Holders of Greek debt will have to take a loss, with some banks having to be recapitalised.
For Greece to return to a more sustainable footing, 50% haircuts are widely seen as the minimum required by investors, which would take projected debt from 160% of GDP to 80% of GDP, a similar level to that held in core Europe.
A 50% haircut today translates to total losses of about €175bn. But the European Banking Authority summer stress tests showed that only about €32bn of Greek government bonds are being held by the non-Greek banking sector.
An additional €60bn now sits at the ECB, and bi-lateral sovereign lenders, including the IMF, now hold between €20bn and €60bn.
So far, discussions of debt restructuring have only included the private sector, with the current aim of reducing the debt to GDP ratio by some 20% – clearly not enough.