Barclays Capital has run a useful exercise on Greece to try and understand the magnitude of the problem facing Europe.
Rather than looking at the country’s outlook based on the fiscal adjustments currently being implemented, the bank’s analysts have assumed a so-called inertial primary balance – or, how debt dynamics would play out without any fiscal adjustment what so ever. In other words, how long it would take to balance the debt position as it stands now.
In that scenario, the primary balance – government net borrowing or net lending excluding interest payments on consolidated government liabilities — could initially improve by 2-3 per cent of GDP over 2010 and 2011. This they say would reduce the primary deficit back to around 5 per cent of GDP in 2011.
The problem comes in the following years, when unaddressed structural issues like rising age-related expenditures and lower growth would drive the primary deficit wider to above 7 per cent by 2015.
This is important because as the IMF definition explains:
[The primary balance] can be said to provide an indicator of current fiscal effort, since interest payments are predetermined by the size of previous deficits. For countries with a large outstanding public debt relative to GDP, achieving a primary surplus is normally viewed as important, being usually necessary (though not sufficient) for a reduction in the debt/GDP ratio
Given the above pre-adjustment scenario therefore the analysts conclude Greece’s current stabilisation programme may be overly optimistic, while its debt plan is likely unsustainable. As they note (our emphasis):
Simulations show that Greece’s debt is clearly unsustainable. However, this is only a hypothetical exercise used to highlight the magnitude of the problem as, markets would be unwilling to finance such a debt path. We therefore need to compute the necessary primary balance adjustment needed to restore ‘solvency’. We ran simulations with different growth paths and interest rates: depending on the assumptions, Greece would need to achieve a primary balance adjustment ranging from 8.5% to 21.8% of GDP
In Figure 3 (click to enlarge), we selected some successful examples of primary fiscal balance adjustments across OECD countries. We also add the potential primary balance adjustment needed in Greece in the next five years (2010-2014), using the criterion of stabilizing the debt ratio at the 2014 level. Only Denmark and Sweden achieved average primary balance adjustments per year around the magnitude Greece will have to achieve now. But then again, Denmark and Sweden achieved their adjustments during episodes of relatively strong growth (in part helped by depreciated real effective exchange rates). This contrasts with Greece’s current situation, which is characterised by a relatively overvalued real exchange rate and weak growth prospects. Overall, it seems fair to say that within the OECD universe the primary fiscal adjustment Greece requires at this juncture has little historical precedent.
Which leads the analysts to conclude that Greece will inevitably have to seek external support to make an adjustment work.
But even on that front there are issues. For example, the IMF might be unwilling to provide financing to maintain such an unsustainable debt situation. In which case, the analysts say, debt restructuring might in fact be the only option.
Related links:
Greece: Take fewer holidays! (and other suggestions) – FT Alphaville
How to borrow €1bn without adding to your public debt figures – FT Alphaville
Greek woes revive seven-year old Goldman swap story – Risk
That Greek CDS trigger – FT Alphaville