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With reports that the Slovak parliament may reject calls to expand the EFSF, what will happen if Greek debt restructuring is needed? Euromoney spoke to Vanden Houte to get a perspective on how likely restructuring is and what needs to be done to contain the spread of contagion. The economist explains why he thinks further restructuring is inevitable, and will likely be sooner rather than later – and why an expanded EFSF must be in place by December, along with solid plans for any necessary bank recapitalisation.
What is going to be the fate of Greece? Have we reached a stage where a default, or restructuring, is not just inevitable but desirable?
Even if you take into account all of the plans that have been made to protect it, Greece is likely to have a debt-to-GDP ratio of around 130%. With such debt, and such low growth, there is little chance of Greece managing to grow its way out of the present situation.
The possibility of a default, or at least of significant debt restructuring, is real. This could go one of two ways: either a mandatory haircut for all investors, or a revision of the voluntary haircuts being taken by the private sector.
If the latter route is taken, the amount of the haircut would need to increase – 21% haircuts will not be sufficient to deliver a significant reduction in the debt-to-GDP ratio. A haircut of around 40% may be enough to make a difference.
There is a possibility that the Slovak parliament may refuse to approve expansion of the EFSF. What would be the ramifications?
If the Slovak parliament refused to approve expansion, then this would complicate things. Markets are looking past the July 21 agreements and considering the possibility of leveraging the EFSF. While discussion has moved on, it’s now possible we may get a delay in expanding the fund.
A delay could be very problematic, with [Angela] Merkel and [Nicolas] Sarkozy saying that they want to have a plan of action ready for the end of the month. This is an ambitious target, even if Slovakia approves of the expansion.
The troika has yet to approve of disbursement of the sixth tranche of the Greece loan – without this, Greece may not last six months. It’s possible that, come December, the talks will be of a Greece restructuring. If it comes to that, an expanded EFSF will be necessary to mitigate the possible spread of contagion to the eurozone’s periphery. Ideally, we’d also see recapitalisation of vulnerable banks.
Have we got to the stage where recapitalisation is a necessity? How much would it take to protect the sector in the case of a Greece restructuring?
In the case of a member state default, restructuring is not going to fix everything. Such a default would be a huge event. We need to be prepared for things to go wrong in Greece, and if we do see a default or restructuring, then recapitalisation will be necessary. A default would put about half of the large European banks in danger, which means that the other half would also be drawn in by their financial connections.
I don’t think an overall recapitalisation would be necessary, rather it would be important to give assurances that any restructuring is just for Greece. The situations in other states can probably be dealt with without such drastic measures.
In the case of a Greece restructuring, around 40 billion euro to 50 billion euro would be needed in recapitalisation – assuming a 50% haircut. Around half of this would to Greek banks, and the other half to banks with Greek debt.
The IMF has mentioned €200bn as a possible figure, but this is grounded in fears of Portuguese and Italian partial defaults, with sizeable haircuts. This hypothesis is a bit too strong – there’s going to be a lot of effort to prevent such restructuring.
Moving on from Greece, what are the risks for other peripheral members of the eurozone?
Spain and Ireland aren’t too concerning. Spain has a private debt problem, but government debt is below the eurozone average. Ireland seems to be able to grow out of its debt problems.
Portugal, however, is hanging in the balance. Both its overall debt and its deficit are quite high, and GDP growth has been low for the last decade. The one saving grace is that should a default or restructuring be necessary, Portugal is small enough that the impact shouldn’t be earth shattering.
An Italian default, however, would make a eurozone collapse highly likely. The good news is that Italy has a fairly low budget deficit, and because of recent pension reforms is going to have a low ageing cost compared with other eurozone countries. It does, however, need new growth impetus – growth is simply too low.
The crucial thing for the ECB and the EFSF to do is to continue to buy up Italian bonds and keep the yields low. If Italian bond yields move into the 8% to 9% area, then the debt will be unsustainable. At around 5%, the level of debt is sustainable.
The ECB is doing this now, and you can see from [Jean-Claude] Trichet and [Mario] Draghi’s letter to Berlusconi that there is pressure on Italy to take appropriate stabilising measures, and I think this pressure will only get stronger in the future.
It seems an increasingly common view that the only ways forward are scrapping the euro or fiscal union – do you agree with this? Which turn of events is more probable?
If the single currency is going to continue, then we will need further fiscal integration, though the question is whether this will be done formally or by stealth.
We may get a situation where the ECB buys peripheral debts that leave it with a loss, which needs to be refinanced, and that the refinancing will have to come from member states. A similar turn of events would be possible for the EFSF. What we would be seeing there is not a formal fiscal union, but it is something approaching it – and is easier to imagine.
If we do not see either a formal fiscal union or union by stealth, then it is likely that the single currency will need to be scrapped.
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