The Hellenic Patient, revisited | FT Alphaville

The Hellenic Patient, revisited

Greece won surprisingly good marks on Thursday for its fiscal reforms under the bailout — at least in the short term.

But what about the medium term?  And what about that debt restructuring risk?

Here’s Morgan Stanley’s Daniele Antonucci and Elga Bartsch. They note a positive early political environment in addition to the fiscal improvements:

…up to now, not only has Greece met the demands of the euro area governments and the IMF; it has done so in the context of no major social or political accident. And socialist – such as Greece’s – or centre-left governments often find it easier than their conservative or centre-right counterparts to engineer a significant fiscal turnaround by negotiating with the trade unions.

Something to bear in mind as we watch for stabilisation fatigue, à l’hongrois. But:

Investors don’t seem very concerned about the short term. Their main worry relates to Greece’s debt burden, which many deem to be unsustainable. After all, the purpose of the adjustment is to stabilise the debt/GDP ratio at less than 150% of GDP in 2012-13. Where to from there?

Well — to Ireland, actually.

Morgan Stanley reckon that the damage to Greek real GDP will eventually match the Irish precedent of -11 per cent from its peak (Greece has seen a four per cent decline so far):

Then again, they also reckon that the private sector will eventually crowd in on structural reforms already made by the government, making up for this contraction.

Strikes us as a pretty sanguine about what would therefore be a rather horrible few years, but it’s an interesting argument that all that front-loading of reform — which Fitch has worried about in particular — might pay off in the long run.

The really interesting argument from Morgan Stanley, however, is where all of this leaves the potential for Greece restructuring its debt burden at some point. In fact, the more successful austerity is, the more attractive default could actually become.

Ironic, that. As Morgan’s analysts note:

In this version of the story, Greece takes the deliberate decision to restructure all or a part of its debt when it manages to bring its primary budget balance (i.e., the overall budget balance excluding interest expenses) back in surplus. This will happen, at best, in 2012, we think. This scenario rests on the key consideration that, as long as the primary budget balance is in deficit, the incentive to restructure is not really there. In these circumstances, cutting the debt will not really solve the problem because, with the government now unable to fund the primary budget deficit, the savings required to balance the books will be substantial anyway…

However, when the primary budget is back in surplus (or when the savings to make ends meet are lower than the interest rate expenses), Greece might be tempted to restructure – according to this line of reasoning – especially if it becomes too evident that the pace of expansion of the economy is too low to sustain the debt-servicing costs (not our central scenario).

Basically, if there’s more domestic pain in fiscal adjustment than there would be for domestic holders of government debt, there’d be a grim logic for strategic default — and if you didn’t mind the international opprobrium associated with defaulting.

It’s thus an interesting scenario to consider — but a much too simplistic one even on the domestic consequences of default, as Morgan hasten to add (emphasis ours):

Greek bank holdings of Greek government bonds amount to no less than €60 billion. The incentive to default on the domestic holders of government bonds is not really there, in our view. Let’s assume, for example, a 50% haircut on the debt held by residents. The annual savings, in terms of reduced debt-servicing costs on this portion of the debt outstanding, could be less than 2ppt of GDP.

Although, if the government is so good at negotiating with national institutions…

Related links:
Et in Arcadia ego – FT Alphaville
Restructuring the Parthenon – FT Alphaville