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Jean Pisani-Ferry
BRUSSELS – For months now, a fight over sovereign-debt restructuring has been raging between those who insist that Greece must continue to honor its signature and those for whom the country’s debt should be partly canceled.
As is often the case in Europe, the crossfire of contradictory official and non-official statements has been throwing markets into turmoil. Confusion abounds; clarity is needed.
The first question is whether Greece is still solvent. This is harder to judge than is the solvency of a firm, because a sovereign state possesses the power to tax. In theory, all that is needed in order to get out of debt is to increase taxes and cut spending.
But the power to tax is not limitless. A government determined to honor its debts at any cost often ends up imposing a tax burden that is disproportionate to the level of services that it supplies; at a certain point, this discrepancy becomes socially and politically unsustainable.
Even if the Greek government were to succeed shortly in stabilizing its debt ratio (soon to reach 150% of GDP), it would be at too high a level to convince creditors to continue lending. Greece will need to reduce its debt ratio considerably before it can return to the capital markets, which implies – even under an optimistic scenario – creating a primary surplus in excess of eight percentage points of GDP. Among advanced-country governments, none (except oil-rich Norway) has managed to achieve a durable primary budget surplus (revenue less non-interest expenditure) exceeding 6% of GDP.
This is too much for a democratic country, especially one where the tax burden is very unequally shared. Greece is, in fact, insolvent.
The second question is how serious a problem it is not to repay one’s debts.
One camp notes that, for decades, no advanced country has dared to do this, and that is why these countries still enjoy a positive reputation. If just one member of the eurozone embarked on the debt-default path, all the rest would immediately come under suspicion. In any case, according to this view, contracts simply must be respected, whatever the cost.
On the other side are those who call for the creditors who triggered the excessive debt to be punished for their imprudence. Lenders must suffer losses, so that they price sovereign risk more accurately in the future and make reckless governments pay higher interest rates.
Both lines of argument are valid, but the fact is that countries that have restructured their debt have not found themselves worse off as a result.
On the contrary, far from being banished from bond markets, they have generally bounced back quickly: investors like a sinner who returns to solvency better than a paragon of virtue on the verge of suffocation.
Twenty years ago, Poland negotiated a reduction in its debt and came off better than Hungary, which was keen to protect its reputation. Debt reduction is not fatal.
The third question is whether a Greek default would be a financial catastrophe – and when it should take place. Two channels are at work, one internal and one external.
First, government bonds are the reference asset for banks and insurers, because they are easily tradable and ensure liquidity. Obviously, any doubt about the value of such bonds could cause turmoil. The Greek banking system’s solvency and access to refinancing would be hit severely.
Externally, in turn, other European banks would be affected. But more importantly, other debt-distressed countries – at least Ireland, Portugal, and Spain – would be vulnerable to financial contagion.
So this is a dire situation. But it does not explain the European Central Bank’s attitude. The central bank has motives to be concerned. But instead of trying to find a way to cushion the possible impact of such a shock, the ECB is rejecting out of hand any sort of restructuring.
Indeed, it is raising the specter of a chain reaction by invoking the collapse of Lehman Brothers in September 2008, and threatening to punish any restructuring by cutting banks’ access to liquidity.
But if Greece is not solvent, either the EU must assume its debts or the risk will hang over it like a sword of Damocles. By refusing a planned and orderly restructuring, the eurozone is exposing itself to the risk of a messy default.
Europe, however, is not obliged to choose between catastrophe and mutualization of debt. The best route – admittedly a narrow road – is initially to beef up the financing program for Greece, which cannot finance itself on the market, while at the same time ensuring through moral suasion that private creditors do not withdraw too easily.
This is what is being attempted at the moment. But this breathing space must be used for more than simply buying time.
It should be used, first, to allow other distressed countries to regain or consolidate their financial credibility, and, second, to pave the way for an orderly restructuring of Greek debt, which requires preparation. Gaining time makes sense only if it helps to solve the problem, rather than prolonging the suffering.
Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis.
As is often the case in Europe, the crossfire of contradictory official and non-official statements has been throwing markets into turmoil. Confusion abounds; clarity is needed.
The first question is whether Greece is still solvent. This is harder to judge than is the solvency of a firm, because a sovereign state possesses the power to tax. In theory, all that is needed in order to get out of debt is to increase taxes and cut spending.
But the power to tax is not limitless. A government determined to honor its debts at any cost often ends up imposing a tax burden that is disproportionate to the level of services that it supplies; at a certain point, this discrepancy becomes socially and politically unsustainable.
Even if the Greek government were to succeed shortly in stabilizing its debt ratio (soon to reach 150% of GDP), it would be at too high a level to convince creditors to continue lending. Greece will need to reduce its debt ratio considerably before it can return to the capital markets, which implies – even under an optimistic scenario – creating a primary surplus in excess of eight percentage points of GDP. Among advanced-country governments, none (except oil-rich Norway) has managed to achieve a durable primary budget surplus (revenue less non-interest expenditure) exceeding 6% of GDP.
This is too much for a democratic country, especially one where the tax burden is very unequally shared. Greece is, in fact, insolvent.
The second question is how serious a problem it is not to repay one’s debts.
One camp notes that, for decades, no advanced country has dared to do this, and that is why these countries still enjoy a positive reputation. If just one member of the eurozone embarked on the debt-default path, all the rest would immediately come under suspicion. In any case, according to this view, contracts simply must be respected, whatever the cost.
On the other side are those who call for the creditors who triggered the excessive debt to be punished for their imprudence. Lenders must suffer losses, so that they price sovereign risk more accurately in the future and make reckless governments pay higher interest rates.
Both lines of argument are valid, but the fact is that countries that have restructured their debt have not found themselves worse off as a result.
On the contrary, far from being banished from bond markets, they have generally bounced back quickly: investors like a sinner who returns to solvency better than a paragon of virtue on the verge of suffocation.
Twenty years ago, Poland negotiated a reduction in its debt and came off better than Hungary, which was keen to protect its reputation. Debt reduction is not fatal.
The third question is whether a Greek default would be a financial catastrophe – and when it should take place. Two channels are at work, one internal and one external.
First, government bonds are the reference asset for banks and insurers, because they are easily tradable and ensure liquidity. Obviously, any doubt about the value of such bonds could cause turmoil. The Greek banking system’s solvency and access to refinancing would be hit severely.
Externally, in turn, other European banks would be affected. But more importantly, other debt-distressed countries – at least Ireland, Portugal, and Spain – would be vulnerable to financial contagion.
So this is a dire situation. But it does not explain the European Central Bank’s attitude. The central bank has motives to be concerned. But instead of trying to find a way to cushion the possible impact of such a shock, the ECB is rejecting out of hand any sort of restructuring.
Indeed, it is raising the specter of a chain reaction by invoking the collapse of Lehman Brothers in September 2008, and threatening to punish any restructuring by cutting banks’ access to liquidity.
But if Greece is not solvent, either the EU must assume its debts or the risk will hang over it like a sword of Damocles. By refusing a planned and orderly restructuring, the eurozone is exposing itself to the risk of a messy default.
Europe, however, is not obliged to choose between catastrophe and mutualization of debt. The best route – admittedly a narrow road – is initially to beef up the financing program for Greece, which cannot finance itself on the market, while at the same time ensuring through moral suasion that private creditors do not withdraw too easily.
This is what is being attempted at the moment. But this breathing space must be used for more than simply buying time.
It should be used, first, to allow other distressed countries to regain or consolidate their financial credibility, and, second, to pave the way for an orderly restructuring of Greek debt, which requires preparation. Gaining time makes sense only if it helps to solve the problem, rather than prolonging the suffering.
Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis.
