A weeklong holiday in Greece last week cemented my view that the country would be far better off it were to default on its debt, leave the Eurozone and revert back to its own currency. A few days in Santorini highlighted the tourism assets (20% of GDP) that Greece has in its islands. I was also positively surprised with the quality of the infrastructure in Athens. The financial press continues to favour a compromise and debt restructuring due to the systemic financial risks of an exit. However, Greece has very little to lose as its economy has ceased to function effectively due to its debt burden and continuing uncertainty regarding its future. If an exit is managed well then they have much to gain in that exiting the Euro as devaluing will improve economic competitiveness and put back to work unutilized resources.
3 Thoughts from my trip:
1) Greece has the potential for a quick economic recovery
Greece’s economy is currently clogged by uncertainty regarding its future. No country can function properly while living in a suspended state where its currency, banking system and political institutions may cease to exist at any point. Under these circumstances it is no surprise that there has been no progress on the economy since 2008. Even if there is another bailout agreement, the uncertainty will continue because a debt burden of 180% of GDP is unpayable. This is understood by Greek citizens and private institutions, even as officials within the Eurozone try to deny it. While a default will be a shock to the system, it will remove the uncertainty overhang that has made the economy dysfunctional. The country will get a massive boost by the elimination of its debt, while the devaluation of the currency will boost its competitiveness and cheapen assets thereby enticing investors.
Threats of being “locked out of financial markets” will prove to be empty. In an environment of surplus global savings and ample liquidity, Greece will not struggle to find alternative creditors. Their funding requirement is not onerous as they are running a primary budget surplus, while their current account deficit is currently 1,5%, having narrowed from 10% since 2012.
The risk to a rapid recovery is a possible descent into populist policies by the left wing government, which will waste the opportunity for a fresh start.
2) 21st Century Politics and Norms makes sovereign debt virtually unenforceable
While Merkel, Draghi and the European political elite have been painting a nightmare outlook for Greece if it defaults and leaves the Eurozone, it is the lenders who are really scared. Greece has around EUR 320bn worth of debt, the majority of it owed to external parties such as the ECB, IMF and the EFSF (European Financial Stability Fund). (http://www.theguardian.com/world/datablog/2015/jun/19/the-greek-debt-what-creditors-may-stand-to-lose) There is a further EUR 80bn borrowed by the Greek banking system via the Target 2 payment systems. This is the means by which Greeks have been able to withdraw Euros even as their banks have run out of money. The European banking system would need to make up this amount and it would have to be done with state assistance. (http://www.yardeni.com/Pub/target2.pdf)
Costs to the Eurozone
For the Eurozone, the cost to Greece defaulting is high, both in monetary terms and in the additional fragility it will add to the Eurozone. It would highlight the fact that countries can exit the Euro, making the currency more fragile. If Greece successfully manages to walk away from its debt burden it will add to the risk that other highly indebted such as Spain and Italy may choose to do the same.
Costs to Greece
Since 2008 Greek debt has migrated from private sector balanced sheets (banks, investors, pension funds) to taxpayer backed institutions like the Eurozone/IMF/ECB investors. (http://money.cnn.com/2015/01/28/investing/greek-debt-who-has-most-to-lose/). With the debt now held largely by foreigners, the cost to Greeks in the case of a government default is relatively low. This is in contrast to South Africa where 65% of the government bonds are held locally by Pensions Funds, Banks and other investors.
While the Eurozone has an incentive to make life as difficult as possible for Greece once they default, there is very little that can be done to enforce sovereign debt payment in the modern world. The Greek state does not hold significant offshore assets, and it would not be easy to attach the assets of Greek citizens. Throughout history war has been used as a means to enforce sovereign debt payments but that would be difficult in today’s political environment. While the European creditors would like the Greek government to sell assets (like its islands) in order pay them back, there is little they can do to force them.
3) Sovereign Debt needs to be Legitimate
Credit quality is defined as the capacity and willingness of an entity to meet its financial obligations. Greece has neither the capacity to pay (given size of the debt burden) nor the willingness (given the electoral victory of Syriza on a debt repudiation platform). The Greek electorate understands that a debt load of 180% of GDP is impossible to recover from without severe sacrifices, no matter how the debt is restructured and how low the interest rate. In the mid 90’s South Africa’s debt burden crept towards the 60% of GDP level, a breach of which risked sending the country into a debt trap. While the 60% level is no longer considered the “Red Line” and interest rates are very low at this point in time, it is difficult to believe that an external debt load 3 times the “debt trap” level is in any way sustainable.
I believe that the Eurozone powers erred in not legitimising the debt restructuring through a democratic process like a referendum. (http://rashaadtayob.blogspot.com/2011/11/referendums-are-solution-to-european.html) In November 2011 then Greek president George Papandreou suggested a referendum on the bailout package. Four days later he was forced to backtrack under pressure from Merkel and Sarkozy and 10 days later he had to resign. Had they gone ahead with the referendum, it would have granted legitimacy to the bailout package and the debt that the people of Greece assumed. Without legitimacy the people of Greece feel no need to continue for further sacrifice in order to pay back the debt, which is why they elected Syriza on the promise of a new deal. Without legitimacy private entities were not willing to hold the debt and it continued to migrate on to Euro/IMF/ECB balance sheets, which means that taxpayers in the Eurozone and globally are now on the hook for the debt.