Greece: the terms of public debt negotiation

After the legislative elections, Greece's new government is asking for debt relief and an exit from its austerity programme. Update on the renegotiations and potential compromises.

5 February 2015

Greece's legislative elections on 25 January resulted in a government led by the radical leftist party, Syriza, in coalition with the Greek Independents party. The new government wants to write off some of its public debt (€320 billion at the end of 2014, nearly 180% of GDP) and exit the austerity programme imposed by the troika (IMF, ECB and the European Commission).

The risks of direct financial contagion are lower today than they were in 2011-2012. On the one hand, because of the haircuts accepted by private creditors in 2012, nearly 80% of Greece's public debt, is currently in the hands of official issuers (eurozone member states, ECB, IMF). On the other hand, foreign banks' exposure to Greece's private sector is now very limited. Nevertheless, from a political perspective it would be hard to imagine a complete write-off of this debt. First of all, it would represent a significant cost for the other countries' tax payers. France's exposure for example is at least €40bn, i.e. more than €600 per inhabitant. What's more, other states that also had to borrow from their partners could then legitimately claim similar relief.

One possible compromise could be to reschedule the debt held with European countries by lengthening maturities and reducing interest charges, possibly even indexing repayments to Greece's economic growth. The possibilities for additional rescheduling are limited however because Greece has already benefited from a sharp fall in the cost of its public debt (2.25% on average in 2014) and an extension of its average maturity up to 30 years. The conditions attached to such rescheduling are also a sensitive matter. On the one hand, Greece's new government wants at all costs to leave the previous austerity programme (which sought a target budget surplus before interest of 4.5% of GDP) and the troika's authority behind it; for this reason it does not want new loans from its international creditors so it can restore sovereignty. On the other hand, it would be hard to persuade European creditors to allow a rescheduling of Greek debt without attaching conditions and a supervisory mechanism. Here also a compromise could involve modifying the conditions related to the budget and reforms (for instance with more emphasis on combating corruption and tax evasion) and implementing a new supervisory mechanism that would seem less "stigmatising" from a political perspective.

Even if avenues of compromise exist, the problem is that the more time passes the more the risks of financial tension increase. Greece has until 28 February to reach an agreement with its creditors and secure $7bn to meet its financing needs for 2015. If no agreement is reached, the government, which does not have access to the international financial markets, could default between now and the summer. Greek banks are also under pressure, with deposit withdrawals on the increase since December and the ECB decision on 4th February to restrict the terms of their access to financing from the Eurosystem, as long as Greece does not succeed in reaching a new agreement with its creditors. Greek banks must now call on emergency liquidity assistance provided by the central Bank of Greece. With so much at stake, it is likely that the first stage in the negotiations will involve buying a few months of time and implementing a temporary solution, before aiming for a new agreement by the summer.

Danielle Schweisguth, Group Economist